AXA Asia Pacific Holdings Ltd v Commissioner of Taxation
[2009] FCA 1427
•4 DECEMBER 2009
FEDERAL COURT OF AUSTRALIA
AXA Asia Pacific Holdings Ltd v Commissioner of Taxation [2009] FCA 1427
Taxation − Capital gains tax − Agreement for sale of wholly-owned subsidiary of taxpayer − Consideration partly to be by way of shares in purchaser − Transaction structured by purchaser’s controlling entity such that scrip-for-scrip roll-over relief under Subdiv 124−M of Income Tax Assessment Act 1997 (Cth) would be available − Whether parties relevantly dealing with each other “at arm’s length”.
Taxation − Income tax − Capital gains tax − Complex transaction for sale and purchase of subsidiary company structured so as to attract operation of scrip-for-scrip roll-over relief provisions of Subdiv 124−M of Income Tax Assessment Act 1997 (Cth) −Purchaser company specifically established as non-wholly-owned subsidiary − Whether amounted to scheme for purposes of Pt IVA of Income Tax Assessment Act 1936 (Cth) − Whether it might reasonably be concluded that transaction would have proceeded other than by way of exchange of shares, or in every respect as it did but where purchaser was wholly-owned subsidiary − Whether taxpayer derived tax benefit from scheme.
Income Tax Assessment Act 1997 (Cth) ss 102-5, 102-20, 104-10, 108-5, 112-105, 124-780, 124-782, 124-783,
Income Tax Assessment Act 1936 (Cth) ss 177A, 177C, 177FCommissioner of Taxation v Peabody (1994) 181 CLR 359, 385
Federal Commissioner of Taxation v Lenzo (2008) 167 FCR 255
Baxter v Commissioner of Taxation (2002) 196 ALR 519
Collis v Federal Commissioner of Taxation (1996) 33 ATR 438
Granby Pty Ltd v Federal Commissioner of Taxation (1995) 129 ALR 503
Trustee for the Estate of the Late AW Furse (No 5) Will Trust v Federal Commissioner of Taxation (1990) 21 ATR 1123
Re Hains (decd);Barnsdall v Federal Commissioner of Taxation (1988) 81 ALR 173
Australian Trade Commission v WA Meat Exports Pty Ltd (1987) 75 ALR 287
ACI Operations Pty Ltd v Berri Ltd (2005) 15 VR 312AXA ASIA PACIFIC HOLDINGS LTD v COMMISSIONER OF TAXATION
VID 1593 of 2005
JESSUP J
4 December 2009
MELBOURNE
IN THE FEDERAL COURT OF AUSTRALIA
VICTORIA DISTRICT REGISTRY
General Division
VID 1593 of 2005
BETWEEN: AXA ASIA PACIFIC HOLDINGS LTD
ApplicantAND: COMMISSIONER OF TAXATION
Respondent
JUDGE:
JESSUP J
DATE OF ORDER:
4 DECEMBER 2009
WHERE MADE:
MELBOURNE
THE COURT ORDERS THAT:
1.The proceeding be listed for the purpose of hearing the parties on the question of the orders that should be made conformably with the reasons of the Court published this day at 9:30 am on 11 December 2009.
Note:Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.
The text of entered orders can be located using eSearch on the Court’s website.
IN THE FEDERAL COURT OF AUSTRALIA
VICTORIA DISTRICT REGISTRY
General Division
VID 1593 of 2005
BETWEEN: AXA ASIA PACIFIC HOLDINGS LTD
ApplicantAND: COMMISSIONER OF TAXATION
Respondent
JUDGE:
JESSUP J
DATE:
4 December 2009
PLACE:
MELBOURNE
REASONS FOR JUDGMENT
This is an appeal under s 14ZZ of the Taxation Administration Act 1953 (Cth) (“the Administrative Act”) by the applicant, AXA Asia Pacific Holdings Limited, against the decision of the respondent, the Commissioner of Taxation, to disallow the applicant’s objection (dated 3 March 2004) against an amended assessment of income tax (dated 18 December 2003) for the year ended 31 December 2002 (in lieu of the year ended 30 June 2003). In that year, the applicant disposed of its shareholding in a wholly-owned subsidiary in circumstances which would give rise to a capital gains tax liability were it not entitled to partial scrip-for-scrip roll-over relief under Subdivision 124-M of the Income Tax Assessment Act 1997 (Cth) (“the 1997 Act”). In disallowing the applicant’s objection, the Commissioner took the view that the applicant and the entity which acquired the shares in the subsidiary did not deal with each other “at arm’s length” within the meaning of s 124-780(4) of the 1997 Act, and that the applicant was not, therefore, entitled to the relief sought. Alternatively, the Commissioner relies upon a determination made under s 177F of the Income Tax Assessment Act 1936 (Cth) (“the 1936 Act”) which brought into account the amount of the tax benefit that, according to the Commissioner, was excluded from the applicant’s assessable income as the result of the operation of a scheme of the kind referred to in Part IVA of that Act. Those two matters, together with the Commissioner’s assessment of penalty tax, are the issues in the present appeal.
THE EVIDENCE
Before the transaction which is presently controversial, AXA Australia Health Insurance Pty Ltd (“AXA Health”) was a wholly-owned subsidiary of the applicant. It operated what I have been told was a profitable health insurance business trading as “HBA” in Victoria and as “Mutual Community” in South Australia. Elsewhere, it wholesaled its products through other financial institutions and advisers. In 2000, the applicant undertook a strategic review of its health insurance business, conducted by a steering committee under the chairmanship of the applicant’s Group Chief Executive, Mr Les Owen. By the end of 2000, the committee had determined that the position of AXA Health in the health insurance market was not sustainable in the long term because it lacked a national footprint and was not well positioned to compete with Medibank Private. The committee had considered a number of courses that might be open to the applicant with respect to AXA Health, including the acquisition of Medical Benefits Fund of Australia Ltd (“MBF”), the acquisition of Medibank Private, the acquisition of a combination of smaller health insurers, a strategic alliance with MBF and, if none of those courses proved viable, the divestment of AXA Health. However, Mr Owen came to the view that the most propitious options were either a merger with MBF (under which arrangement the applicant would have effective control of the combined business) or the sale of the existing business to MBF. It seems that some kind of transaction with MBF was seen as an ideal means by which to maximise the value at which AXA Health was merged or sold because of the “synergies” which would arise from combining the two businesses. MBF operated predominantly in New South Wales and Queensland, and a combined business would, therefore, have much closer to a national footprint than either of the existing businesses had.
In early 2001, the applicant engaged the services of Macquarie Bank Limited (“MBL”) through its advisory arm (“MBL Advisory”) to assist it with a consideration of, and with the implementation of, an approach to MBF. Negotiations between the applicant and MBF followed and, although I do not need to refer to them in detail, on any view there was, in the first half of 2001, a serious and determined endeavour to find a way in which the business of MBF might be merged with that of AXA Health to the advantage of both. However, largely because both companies sought to achieve control of any merged business, by July 2001 the negotiations concluded without resolution.
But the negotiations had aroused a degree of interest in AXA Health on the part of MBF. By letter to the applicant dated 27 July 2001, MBF made what it described as “an indicative proposal” for the acquisition of AXA Health. That proposal involved a headline price of $430m, of which $250m would be paid on settlement and the balance would be the subject of vendor finance in various alternative ways set out in the letter. On 13 August 2001, MBF made a revised proposal, in which the headline price was increased to $535m, but which left the sum to be paid on settlement unchanged at $250m. That proposal was considered by the Board of the applicant on 29 August 2001. It had before it a paper which dealt with various aspects of the proposal and of the applicant’s own valuation of AXA Health. The paper included a chart which indicated that the applicant’s “stand alone” valuation of AXA Health was $570m, subject to the following note: “Tax effect (CGT and revenue loss tradeoffs) will impact on net proceeds….” To that the chart added $105m, being one-half of the applicant’s valuation of the “agreed synergies”, giving a total valuation of $675m. The MBF proposal was shy of this figure by a considerable margin. The paper included the following note (where, as in a number of documents to which I shall refer, the applicant was referred to as “AXA”):
Given that the sale of AXA Health may crystallise a CGT liability for [the applicant]… from a cost base of $40m (tax liability of $140m+), the offer remains significantly below AXA’s current value expectations for a sale
The Board resolved to give MBF a short period of exclusivity (as it had requested), with appropriate milestones, to enable the parties to move towards a more satisfactory price and funding structure.
Within broadly the same time frame, MBL Advisory was assisting the applicant to locate other potential sources of interest in the acquisition of AXA Health. One of those was British United Provident Insurance Ltd (“BUPA”) of the United Kingdom. In August 2001, Ms Marianne Birch, a Division Director within MBL Advisory, was part of a group which met with representatives of BUPA in London. Those representatives informed the group from MBL Advisory that an outright acquisition of an Australian health insurer was “neither contemplated nor achievable”. MBL Advisory also contacted several Australian financial service providers, and ultimately formed the conclusion that there was little or no domestic or foreign interest in the acquisition of AXA Health.
By October 2001, MBL Advisory had become concerned that, in the words of Ms Birch, “there were no competitive forces driving the negotiations with MBF”. There was concern also about the ability of MBF to fund any acquisition. MBL Advisory, therefore, commenced to investigate the viability of an initial public offering (“IPO”) of AXA Health, and sought input from MBL’s Equity Capital Markets Group in this regard. MBL Advisory also began to explore the option of a leveraged buy out (“LBO”) of AXA Health. According to Ms Birch, an LBO was “the purchase of a company by an investor or a consortium of investors that would fund the acquisition using predominantly debt finance”. For this purpose, MBL Advisory contacted another arm of MBL, the “Principal Transactions Group” (“MBL PTG”). The role of MBL PTG, within MBL, was to originate, participate in and generate revenue from, mergers, acquisitions and other corporate transactions through the utilisation of MBL’s balance sheet. Mr Richard Facioni, an Executive Director of MBL, was the head of MBL PTG. He was one of a number of recipients of an email sent on 18 November 2001 by another Division Director of MBL Advisory, Mr Mark McLean. In the email, Mr McLean set out in some detail the state of the applicant’s negotiations with MBF and various pricing and funding parameters involved therein, together with comments about the possibility of an IPO or an LBO. He noted that Ms Susan Foster, the Strategic Projects Manager of the applicant, had raised the idea of an LBO the previous week, and that Mr Facioni was “running with this”. He said that a meeting had been arranged for 21 November 2001, which would be attended by Ms Foster and Mr Andrew Penn, the General Manager of Operations of the applicant. MBL Advisory would make a presentation at that meeting. Mr McLean said (in his email):
Andy [Penn] is the key person here: we need to structure the presentation so that it is over in 45 minutes, and we can spend the rest of the hour talking through issues with Andy and Susan.
The presentation went ahead on 21 November 2001. Mr Owen, Mr Penn and Ms Foster were present on behalf of the applicant. In the presentation (as recorded in a documentary version thereof) the LBO part of the proposal was developed in some detail. It was proposed that AXA Health could be sold “into an unlisted, leveraged structure”, the process being described as a “structured sale”. A company would be established to acquire AXA Health, in which MBL, together with other investors yet to be identified, would hold the equity. Debt finance of the order of $300m would be obtained. It was noted that the process could be conducted in parallel with a trade sale to MBF, at no additional cost to the applicant. I understand this to mean that, if the applicant’s negotiations with MBF came to fruition, AXA Health could be on-sold from the MBL structure to MBF.
The events to which I have just referred did not reflect a diminution in the applicant’s interest in a sale of AXA Health to MBF. Correspondence in the first week of November 2001 between Mr Owen and the chairman of the Board of MBF, Mr John Conde, made it clear that both men were keen for such a sale to occur. Mr Owen gave MBF a further period of exclusivity, to run until 31 December 2001, during which the applicant would not negotiate with any other party for the sale of AXA Health. A paper, prepared by Mr Penn and considered by the Board of the applicant at its meeting on 30 November 2001, made it clear that, save for a sale to MBF, the prospects of disposing of AXA Health for a price in line with the applicant’s expectations were limited. Mr Penn (who was the executive charged with the overall responsibility of disposing of AXA Health on the most favourable terms) proposed that the Board should consider an IPO or an LBO as suggested by MBL Advisory. The Board resolved to continue discussions with MBF, but at the same time to progress investigations into the IPO and LBO options to determine price and feasibility.
A confidential memorandum was prepared in MBL PTG on 7 December 2001. It proposed the use of a new entity – “BidCo” – to acquire AXA Health from the applicant. It contemplated that the shareholders in BidCo would be investors in the acquisition. There would also be a need for some debt finance. The acquisition as such was diagrammatically represented as a transfer of AXA Health shares from the applicant to BidCo in return for “Purchase Price”. The memorandum dealt, in rather broad outline, with the advantages to MBL of such a transaction, and with the commercial and financial risks involved. Under the heading “Potential Upside” the following appeared:
Transaction structuring opportunities:
Manage capital gains tax exposure for AXA on sale (share in up to $100m NPV uplift to AXA)Of that notation, Mr Facioni said in his evidence:
… we were aware of the potential exposure that AXA had and to the extent that AXA was able to reduce that exposure that would provide us with an opportunity … to capture some of that value.
At this stage, there was no mention of a scrip-for-scrip share exchange, but the memorandum, and Mr Facioni’s evidence about it, leaves little doubt that at least someone in MBL PTG had it in mind to structure the transaction in such a way that capital gains tax would not be payable. A form of the memorandum (in terms which, relevantly for present purposes, were unchanged from those referred to or set out above) was sent to the chief executive officer of MBL and to the head of the Investment Banking Group within MBL on 9 December 2001.
The applicant’s Board met on 20 December 2001. It considered a paper which compared various options for the disposal of AXA Health. Evidently, MBL Advisory had made an important contribution to the contents of the paper. Of the LBO option, the paper recorded the following:
Macquarie have confirmed their indicative estimate of value to be $550-600m, where Macquarie would partner with 2-3 private investors to hold the equity (up to 250m) and seek a commercial bank (ANZ) to hold the debt (up to 350m)
The paper concluded with the following recommendation:
· We retain a tough line with MBF and largely hold our current position
· We state that our position is on a non financing basis give [sic] their lack of willingness to negotiate these terms
· We do not extend exclusivity with them beyond the end of December unless there is agreement on value
· If this is achieved we give them one month to sort out financing
· If not we pursue IPO/LBO alternative but without precluding ongoing discussions with MBF
· We request a Board sub-committee be appointed to approve the commercial terms should they be agreed over January
This recommendation was endorsed, and the Board appointed a sub-committee to “approve the commercial terms”. Because of the then exclusivity which had been granted by the applicant to MBF, however, the opportunity for negotiations between the applicant and MBL was limited.
On 2 January 2002 (ie almost immediately after the expiration of the period of exclusivity that had been provided to MBF), Mr Ed Westhead of MBL Advisory sent Mr Penn a table setting out the net present value (@ 12%) of the various options that were then potentially available for the sale of AXA Health. The tax payable by the applicant was indicated in each case. That estimated to be payable under the “LBO” option (ie the contemplated proposal from MBL) was in the range $48m to $93m. The tax payable in respect of the other options was shown to be in the range $131m to $177m. When asked whether anybody from the applicant’s end was then in discussions with MBL about how much tax would be payable in respect of the sale of AXA Health, Mr Penn said:
Well, the tax that was payable was one of the economic implications of the – economic implications of the transaction, so, yes, undoubtedly we would have discussed it with our corporate advisers as well as our Board during the process of the transaction.
I do not read this as indicating that there were any discussions as between the applicant and MBL PTG: the applicant’s “corporate advisers” were MBL Advisory.
A confidential memorandum prepared in MBL PTG on 22 January 2002 identified the following “key steps” in its proposal for an LBO of AXA Health:
1.MBL would establish a new group company (Bidco) and will fund Bidco by an issue of redeemable preference shares (RPS).
2.AXA would sell AXA Health to Bidco for, say, $575 million, comprising $50 million cash and $525 million of vendor finance. The $50 million would effectively be a non-refundable deposit paid by Bidco at the time AXA Health is acquired by Bidco.
3.The vendor finance would be provided against the issue of converting shares issued by Bidco to AXA (Vendor Shares) with a face value of $525 million. Indicative terms of Vendor Shares follows:
Vendor Shares – Indicative Terms Face Value: $1 per Vendor Share
Number Issued: 525 million
Term: Perpetual, subject to Vendor’s right to convert.Conversion: Convertible, at AXA’s option, into ordinary shares in Bidco at a 1:1 ratio anytime after 6 months from the date of issue
Security:Vendor Shares can be put to MBL (Vendor Option)
in certain circumstances (described below). N
4.MBL would have the option to put to AXA its ordinary shares in Bidco for their nominal market value (MBL Option). The MBL Option would be exercisable anytime within the first 6 months from the date of issue of the ordinary shares in Bidco. MBL requires the MBL Option for the following reasons:
-in the event that MBL has not been able to on-sell AXA Health, MBL is able to return AXA Health to AXA with MBL foregoing the non-refundable deposit of $50 million; or
-in the event that MBL has been able to on-sell AXA Health, MBL is able to rationalise the residual corporate structure.
In the event that MBL fails to on-sell AXA Health, it will have the choice of either foregoing the non-refundable deposit or providing the remainder of the vendor finance from its own sources – this would be a commercial decision that would be addressed at the time if the situation arose.
5.The RPS held by MBL will be automatically redeemed as follows:
-upon the sale of AXA Health (or its assets) by Bidco – for the excess of the sale consideration over the face value of the Vendor Shares; or
-upon the exercise of the MBL Option, the Vendor Option or upon expiry of 6 months – for no consideration.
Accordingly, if Bidco sell the shares in AXA Health, for, say, $575 million, the RPS would be automatically redeemed for $50 million (ie $575 million less $525 million) and Bidco would replace the remaining cash (ie $525 million) on deposit with a financial institution.
6.To provide AXA with a fallback exit mechanism, MBL will grant AXA an option to put its Vendor Shares to MBL for $525 million plus an agreed premium (Vendor Option). This option would be exercisable 6 months after the date of issue of the Vendor Shares and only in the event that the MBL Option has not been exercised.
The memorandum represented the first documentary reference to the idea of providing that the non-deposit part of the consideration for the applicant’s shares in AXA Health be in the form of convertible shares in BidCo.
Also in January 2002, representatives of BUPA visited Australia, and requested a meeting with MBL Advisory. That meeting took place on 16 January. The BUPA representatives indicated that BUPA’s strategy was either to leave the Australian market or to adopt a growth strategy, the acquisition of Medibank Private being of particular interest. When the nature of BUPA’s thinking was communicated to Mr Owen, he authorised MBL Advisory to raise with BUPA the possibility of it participating in the LBO proposed by MBL PTG, or of it making a bid for the outright acquisition of AXA Health. That was done, and Mr Dean Holden, Managing Director of BUPA International, later told Ms Birch that BUPA could not finance an outright acquisition of AXA Health, but was keen to participate in an LBO by contributing equity. Ms Birch gave Mr Holden Mr Facioni’s telephone number, and made it clear to him that she and others at MBL Advisory could not deal with BUPA on the matter of equity participation in an LBO, since “Chinese Wall” procedures had been put in place between MBL Advisory and MBL PTG in relation to the disposition of AXA Health.
Mr Holden did speak to Mr Facioni by telephone. In one of their conversations, Mr Holden said that BUPA’s commitment to the equity consortium had been internally approved by BUPA. He said that participation in the LBO as a consortium member made sense for BUPA because, although its financial capacity to acquire AXA Health was constrained, it nevertheless wanted to expand its business internationally. On 12 February 2002, Mr Facioni sent a detailed briefing paper to Mr Holden. In the “overview” section of the paper, Mr Facioni said (referring to the LBO as an “MBO”):
The MBO of AXA Health would be undertaken by an independently capitalised investment vehicle (BidCo), financed through a combination of:
-Equity, to be provided by private equity investors, which could include existing AXA management, Macquarie and other private equity investors; and
-Acquisition financing of $350 million to be provided by banks and institutions.
The “key financial and operating characteristics” were explained under the following headings: market leading positions, with well-established brand names; long-life asset with high barriers to entry; lowest claims and management expense ratios; low fixed costs; experienced management team; a growing market; favourable regulatory environment; financial performance being insulated from economic conditions; and consolidation opportunities within the industry.
In his briefing paper for BUPA, Mr Facioni summarised the financial position of AXA Health, and described the characteristics of the private health insurance industry in Australia. He explained various features of the business of AXA Health. In the section headed “Acquisition Funding”, Mr Facioni said that MBL was “seeking an indication from a number of banks … as to their preparedness to provide and/or underwrite senior and secured credit facilities of $350 million to partly fund the acquisition of AXA Health by BidCo”. He set out the proposed financing structure as follows:
The sources and uses of funds were summarised as follows:
Use of funds $m Source of funds $m
Acquisition Price 480 Equity* 215
Deferred Consideration 65 Senior Debt 350
Transaction Costs 20Total Acquisition Cost 565 Total Acquisition Cost 565
Under the heading “Bidding Consortium”, Mr Facioni said:
Macquarie is seeking two to three co-investors to participate in the transaction through an equity investment in BidCo, the independently capitalised vehicle that would acquire AXA Health. Equity would also include around $65 million of deferred, contingent consideration which would be payable to AXA in the event certain financial targets are achieved. The amount and terms of deferred consideration are yet to be agreed with AXA.
Macquarie would be retained as financial advisors to BidCo, and, as such would receive fees in regard to financial advice and debt and equity arranging. Costs incurred by BidCo, including legal fees and consulting fees charged by an industry expert, are to be shared equally between consortium investors.Finally, Mr Facioni set out what he described as “exit options”, namely an immediate IPO, a deferred IPO within 2-3 years and a trade sale within 2-3 years.
Meantime, the applicant was still considering a sale of AXA Health to MBF. Indeed, in a memorandum to Mr Owen on 11 February 2002, Mr Penn as good as expressed a preference for such a sale over the proposal then offered by MBL PTG. Mr Penn said that he had had MBF confirm that they were “working to a deal based on $590m on completion plus $10m on approval of 2003 price increase and a marketing agreement”. Mr Penn also said:
[MBF] are targeting the end of the month for the above at which point it is contemplated we could go straight to contracts subject only to regulatory approvals, confirmatory due diligence identifying something of a very material nature and some limited conditions around financing. I had to negotiate them back from early March to end of Feb although I am not convinced they will meet the timetable. I have warned them we are advancing other options and timing is an issue if they take too long they may miss out.
In the same memorandum, Mr Penn said that the “LBO team” (ie MBL PTG) had “come back below their indicative value range” and that, in his view, this had much to do with the internal rate of return which had been built into the assumptions used by that team. Mr Penn said that he had extended “their timetable” to 22 February 2002, and that he did not want an offer from MBL PTG “too much before we are able to get something concrete” from MBF. He concluded his memorandum with the following paragraph:
[F]inally regarding structure I have now had a chance to get my own head around this. I will brief you verbally. At this stage however I am not convinced that their [sic] is any upside in the LBO deal over and above that available in the [MBF] deal after taking all risks and probabilities into account. I am therefore only comparing the gross value of the two deals at the moment. On this basis [MBF] is looking better but we have a way to go.
An internal briefing note prepared within MBL PTG on 22 February 2002 identified the members of the consortium that was then proposed to make up the participation in BidCo. They were MBL and three “equity participants”, one of which was BUPA. Mr Facioni considered it to be advantageous to have as a member of the proposed consortium a company that operated in the health insurance industry. The same briefing paper referred to the fees that MBL then expected to derive from the overall transaction which was proposed, including a “structuring fee” of up to $10m and a “consortium advisory fee” of up to $10m.
In February 2002, drafts of what was then described as an “indicative bid” for AXA Health were prepared within MBL PTG. In a draft of 25 February 2002, under the heading “Bidder Details”, it was said that the acquisition would be undertaken through a special purpose company, “99.9% owned” by MBL, called Macquarie Health Acquisitions Pty Ltd (“MHA”). A diagram representing the proposed structure and transaction is as follows:
An annexure to the document, titled “Terms of Vendor Shares” identified the issuer of the vendor shares as MHA, “a non-wholly owned member of the Macquarie group”.
A later draft of the same document, prepared on 27 February 2002, stated that the consideration for the acquisition would take the form of a deposit (then suggested to be $50m), a special dividend payable by AXA Health to the applicant, and vendor financing in the form of converting vendor shares in AXA Health. Under the heading “Bidder Details”, it was said that the acquisition would be undertaken through MHA, but there was no reference in the text to the extent to which it would be owned by MBL. However, a diagram represented the proposed structure and transaction as follows:
Beneath that diagram, Mr Facioni wrote: “Do we need to show ‘Outside Equity’ above? It looks a little contrived.” Under cross-examination, Mr Facioni said that he could not recall making that endorsement, but accepted that it was a reasonable assumption that he did so because “MHH” (a company which had not then been introduced into the structure and to which I shall refer further below) had no role other than to hold shares in MHA. Further, beneath the diagram, under the heading “Pre-Signing Steps”, it was stated that MHA would be established with nominal ordinary equity “with Macquarie holding 99%”. Mr Facioni crossed out that last quoted passage. Mr Facioni did not, however, make changes to the annexure, which still stated that MHA would be a non-wholly owned member of the Macquarie group.At the time of these events, Mr Patrick Upfold was an executive within MBL PTG. He and those who worked with him were responsible for devising the details of the structure by which AXA Health would be acquired (if there were to be an acquisition). His instructions from Mr Facioni were to structure the transaction in a way that would facilitate a commercially attractive offer to the applicant and enable MBL to on-sell its stake in AXA Health in an efficient manner as soon as possible following completion, preferably at a profit, and with minimal risk to MBL. Mr Upfold had very little recollection of the details of discussions involving the development of the structure for the proposed acquisition of AXA Health. He thought it likely that he would have followed his usual practice of conducting “brainstorming” sessions with staff, with ideas being formulated, drawn on a whiteboard and debated. In his evidence, Mr Upfold referred to the feature of the structure then being developed which involved the holding of 1% of a company, otherwise owned by MBL, by outside interests. He said:
I do not now recall the particular reasons at the time for deciding upon those shareholdings. I have not been able to locate any contemporaneous document recording any such reasons that would assist me to refresh my memory. However, I do recall that it was a feature of the structure that it could provide the applicant with the choice of obtaining for [sic] scrip for scrip roll-over relief under the income tax legislation.
Something else which Mr Upfold did recall was that the process of structuring the transaction did not involve any input from the applicant.
Mr Upfold said that the proposed structure of MHA – by which 1% would be held outside the MBL Group – had the additional “feature” that MHA would not form part of the MBL tax consolidated group when it was formed. In his affidavit sworn on 23 September 2009, Mr Upfold said:
At the time the structure for the transaction was being developed, the tax consolidation regime had been announced but legislation had not yet been finalised. I recall at that time that there was still some uncertainty as to the details of the final legislation. I also recall that MBL was contemplating forming a tax consolidated group during the period covered by the transaction. I was concerned that MHA and AXA Health should not form part of the consolidated group, and that the transaction should not affect the timing of the decision to form the group. I was aware that it was MBL’s intention to on-sell AXA Health at the earliest opportunity. I was also aware that there was no intention for MBL to integrate the AXA Health business, staff or systems within the broader MBL business. In those circumstances, it was desirable that the tax outcomes associated with AXA Health should remain isolated from MBL. Furthermore, I was concerned that if MHA or AXA Health were consolidated with MBL for tax purposes, MBL would be required to provide tax indemnities to any third party purchaser of AXA Health. Having to provide such indemnities would have been commercially undesirable and would have entailed risk to MBL
Returning to the applicant’s consideration of the proposals for the sale of AXA Health, on 27 February 2002 Mr Owen prepared a paper for consideration at the meeting of the Board. Both MBF and MBL PTG were expected to submit offers within the ensuing days or weeks. Mr Owen concluded his paper as follows:
We continue to make progress, albeit slow, on both options for the sale of our health business.
Whilst the MBF deal offers a higher gross value on the face of it, they have not yet finished their commercial due diligence and we believe, based on experience to date, that there is significant completion risk associated with this option.
The LBO team look to be very well placed to put in their offer on 22 February and we believe that were we to accept their offer there would be a very high probability of completion. Their offer is however, likely to be at a value which is unacceptable to us.
It is feasible that we will be able to lift the value of the LBO offer through some economic exposure however this may also expose us to some downside risk.
The recent speculation regarding our strategy for our health business has not exposed any other interested parties and we therefore remain convinced that the best options for the sale of the business are those currently under consideration.
Our strategy is to continue to work with both parties with a view to maximising the value of their respective offers and getting them to a position where completion risk on either option is at a minimum. At that point we would proceed with the preferred offer. Managing this situation and keeping “both balls in the air at once” is, however, extremely delicate.
The minutes of the Board meeting record the following:
Discussion turned to the leveraged buy out proposal. The Macquarie Bank team appear to have strong lines of equity participation with possible participation by BUPA, a substantial United Kingdom based private health company. It seems likely that the LBO team is intending to realise their investment through a subsequent IPO. We are seeking to ensure participation in any excess over the offer from the LBO team.
On 1 March 2002, MBL made a “non-binding bid” for AXA Health. The form of the bid was devised by MBL PTG and other groups within MBL, not including MBL Advisory. The applicant had no input into the structure or the form of the bid. By the bid, MBL proposed to acquire 100% of the shares in AXA Health “by way of unconditional underwriting”. The bid provided:
Macquarie is not a strategic acquirer nor a long-term owner of AXA Health. Macquarie understands that AXA wishes to divest AXA Health and is seeking certainty regarding the timing and price of such a sale within a relatively short timeframe. Macquarie believes that Macquarie Unconditional Underwriting achieves these objectives for AXA, whilst providing AXA with some continued upside exposure to any IPO of AXA Health in the short-term. Under the Macquarie Unconditional Underwriting, Macquarie would assume the risk of on-selling AXA Health.
Macquarie proposes to sell-down all or a substantial share of its investment in AXA Health … within 6 months of Completion Date…. It is envisaged that the Macquarie Sell-down would be undertaken either by way of an on-sale to a private equity consortium … or an IPO on the Australian Stock Exchange.
The bid provided for the applicant to receive a minimum of $550m for the sale of AXA Health, plus “up to a further $10 million if AXA Health is subsequently sold by way of an IPO within 12 months.” An attractive feature of the arrangement, so it was said, was that the applicant would have to deal with one party only (MBL), and MBL would assume the risk of failure of the proposed IPO. The consideration proposed by the bid was –
-$65 million Deposit; plus
-485 million Vendor Shares issued by MHA with a face value of $1 each; plus
-an additional payment of up to $10 million in the event that AXA Health is sold by way of an IPO within 12 months of Completion Date, calculated as 30% of the net proceeds received from an IPO (ie. net of IPO costs) above $575 million.
Because MBL did not intend to be a long-term equity owner of AXA health, the bid was structured to provide MBL with a period of six months during which it would have effective control of AXA Health without the applicant yet having received full consideration for the sale. The idea was, however, that it would be MBL which would bear the risk of there being no third party investor interested in acquiring AXA Health. Broadly, that was done in two ways: first, by providing for a cash payment of $65m by way of non-refundable deposit, and secondly, by giving the applicant a range of options exercisable at the end of the six-month period that would enable it either to require MBL to proceed with the acquisition for the total price of $550m or to resume full ownership of AXA Health.
In its non-binding bid, MBL proposed that the acquisition of AXA Health would be by way of a “special purpose company”, MHA. That company (which was the company previously referred to as “BidCo” and which did not then exist) would be established as a subsidiary of MBL with a nominal capital (suggested to be $100). It would issue 65,000,000 $1 redeemable preference shares to MBL. By subscribing for these shares, MBL would put MHA in funds to the extent necessary to enable it to pay the $65m non-refundable deposit for AXA Health to the applicant. The remaining component of the consideration passing from MBL to the applicant – to make up the total price of $550m – would be 485,000,000 convertible $1 “vendor shares” in MHA. During the six-month period to which I have referred, these shares would carry voting rights only on the basis of one vote for every 100 shares. By reason of its 100 ordinary shares and its 65,000,000 redeemable preference shares (which were to carry ordinary voting rights), therefore, MBL would control MHA on the proposed figures; (the applicant’s vote at a general meeting would be of the order of 6.9%). MHA, in turn, would own 100% of the shareholding in AXA Health. The commercial effect of this was that the applicant would – save to the extent of the $65m deposit – be providing vendor finance for the sale of AXA Health to MBL.
At the end of the six-month period, it was proposed that the applicant would have the option to convert its vendor shares in MHA into ordinary shares with full voting rights. It could then either keep them, or put them to MBL at a price of $1 per share. Should the applicant exercise the put option, it would have effectively disposed of its interest in AXA Health for a total consideration of $550m. Alternatively, should the applicant retain its shareholding in MHA, it would control whatever assets MHA then had, which would in turn depend on MBL’s measure of success in selling the business of AXA Health to a third party (or parties). Effectively, the applicant would have either a cash box company or the continuing business of AXA Health.
The arrangements just described were depicted schematically in the bid document as follows:
Macquarie AXA Choice AXA Outcomes
Sell-downThe entities involved in the transactions contemplated by the bid, and the movement of shares and funds, were represented by the following diagram:
Although the bid document no longer (ie since Mr Facioni’s deletions from the draft of 27 February) contained any explicit reference to the 1% outside shareholding, the annexure (now Annexure 1) identified the issuer of the vendor shares, MHA, as “a non-wholly owned member of the Macquarie group”. It was put to Mr Upfold that there was an inconsistency between that indication and the above diagram. He rejected that, saying that the words “group company” in the diagram was “an accounting concept rather than a legal concept”, and that the diagram did not tell him too much about the legal ownership of MHA by MBL. By contrast, the annexure was “essentially a … sheet of legal terms” which served a different purpose.
Mr Upfold said that he was, in April and May 2002, familiar with the requirements for scrip-for-scrip rollover under the tax legislation. He also had a recollection, albeit not a specific one, that, in the transaction which he and his colleagues were preparing, it was necessary for the vendor shares to be issued by a company that was an ultimate holding company. He accepted that the need to satisfy that requirement was a factor in the decision to insert a small component of outside equity into the structure.
MBL was, of course, a financial institution with no long-term desire to operate the business of a health insurance fund. It seems that it saw the sale of AXA Health as an opportunity to earn revenue from a facilitation of that sale, in part by the assumption of risk that third party equity investors could not be found. Thus it described the proposed transactions referred to above as “underwriting”. In the bid, MBL proposed that the applicant would pay an “underwriting fee” of $10m on completion of the transaction. As it happened, at the time of the bid MBL already had non-binding commitments from a number of investors (including BUPA), and indications from other banks of a preparedness to provide debt finance to the extent necessary.
Mr Penn informed Mr Owen of the receipt of the non-binding bid from MBL in an email sent on 2 March 2002. He referred, in summary, to the features of the bid. In the course of that email, Mr Penn said:
There is a $10m structuring fee proposed, you know what this is for. It is not conditional on the actual structural outcome, it is payable on our acceptance of the offer which incorporates the proposed structure.
Mr Penn was asked about this in cross-examination. He accepted that, in the light of his comment in the email, MBL PTG most probably described the fee to him as a “structuring fee”, adding:
I understood it to be a fee for the overall structure of the transaction, which included the on-sale and the shifting of risk to Macquarie during a period of six months, and then the potential clawback of the business to us.
As to the passage “you know what this is for”, Mr Penn at first said that he had previously spoken to Mr Owen about the fee, and that the latter did indeed know what it was for. When pressed, he offered the view that it was “a fee associated with us accepting the offer from Macquarie in relation to this transaction”. When it was put to him that it was a payment for devising the structure, rather than a payment for underwriting as such, Mr Penn did not agree. He said:
It was a payment which was associated with accepting the transaction, and Macquarie were shifting risk to them. It was a fee associated – it was a fee which was – that the transaction was conditional on accepting.
By letter dated 8 March 2002, the applicant gave limited, provisional and somewhat cautious support to the MBL bid. It required a number of issues to be addressed. It required the voting entitlements of the vendor shares in MHA to be increased to a level which was greater than 25% and the distribution entitlements to match the voting entitlements. This was (although not then expressed in the letter in terms) because the applicant wanted to be in a position, during the period when MHA would be controlled by MBL, to block the passage of any resolution at a general meeting which required 75% shareholder approval. The applicant required certain amendments to be made to the constitution of MHA, and indicated that it may require representation on the Board. It also required an adjustment to the rights associated with the put option attaching to the vendor shares, and the creation of a call option over MBL’s shares in MHA, as follows:
d) Vendor Option – Amend the rights to reflect that in the event of a successful sell-down for an amount less that [sic] the underwritten amount, the option is to act as a guarantee to AXA to top up to the underwritten amount; and
e) Call Option – AXA will require a call option over Macquarie Bank’s ordinary shares in MHA with an exercise price of $1.00 per ordinary share. In the event that AXA converts its Vendor Shares, AXA will require total control of AXA Health.
In its letter of 8 March 2002, the applicant also proposed a number of other modifications to MBL’s bid. Included amongst them was a requirement for a “base” price of $560m and a requirement that the applicant share, to the extent of 50%, in any profit made from the on-sale of AXA Health (under certain conditions).
Also on 8 March 2002, Mr Facioni wrote to four potential investors in the proposed consortium, including BUPA. He attached a summary of the applicant’s response to the non-binding bid of 1 March 2002. I infer that those investors were already privy to the details of that bid. In his letter, Mr Facioni said that the applicant’s comments on the bid fell into three broad categories: bid value, process and structure. He gave brief details of the response under each of these headings. He set up a teleconference with representatives of the investors for 12 March 2002.
On 16 April 2002, MBL submitted a revised non-binding bid for AXA Health, which followed the same general approach as the original bid of 1 March 2002, but was more favourable to the applicant in a number of respects. The total price was now to be $560m, made up of a $65m cash deposit and convertible vendor shares to the value of $495m. The applicant was to be entitled to a share of 50% (reducing pro-rata to 30% over 12 months) of the profit made from any on-sale of AXA Health for more than $575m (net of costs) within 12 months of the completion date agreed as between MBL and the applicant. The revised bid contained further details about MHA: it was to be majority-owned by MBL, “with the other shareholder … being a non-wholly owned subsidiary of [MBL] that is controlled by [MBL]”. As MHA would be controlled by MBL, it would be “a member of the [MBL] consolidated accounting group”. The applicant was to have the call option on which it had insisted in its letter of 8 March 2002. The way that option was expressed gave an indication of the ownership structure which MBL had in mind for MHA. As to 99 ordinary shares in MHA, the call option would be granted by MBL. As to one ordinary share, it would be granted by a company not otherwise mentioned in the revised bid, and not then incorporated, Macquarie Health Holdings Pty Ltd (“MHH”). It was also proposed that, subject to negotiation, the applicant would have 25% of the voting power at a general meeting of MHA, and would have one seat on the Board.
On 17 April 2002, the Board of the applicant considered the options that were then potentially available for the disposal of AXA Health. Two of those options were the sale to MBF and the non-binding bid from MBL. The documents which were then before the Board leave little doubt but that the capital gains tax consequences of proceeding by way of a scrip-for-scrip roll-over were a significant matter for consideration. One of those documents was a detailed briefing paper, in which a table headed “Impact on AXA APH financials” compared the overall financial impact of the various options, in each case showing the best and worst case scenarios. For the “LBO” option (ie the one being proposed by MBL) there were best and worst cases of $-17m and $-133m respectively shown with respect to “Tax paid by AXA APH”. Mr Richard Allert, the chairman of the applicant, accepted that, at its meeting on 17 April 2002, the Board understood that the way an LBO might be structured could bring about the consequence that less tax was payable. Indeed, a notation on the final page of the briefing paper (not referred to Mr Allert by counsel for the Commissioner) was as follows:
Tax & Accounting
-No CGT payable by AXA on transaction as consideration for AXA Health shares equals cost base of shares
That comment did, of course, reflect a technical misunderstanding of what was being proposed by MBL PTG, but it at least demonstrated an awareness of the undoubted circumstance that the proposal was structured in a way that delivered capital gains tax benefits. In his evidence, Mr Owen made it clear that he then understood what was being proposed. He said:
I understood that under the offer we have received from Macquarie that there would be roll-over relief on the capital gain. We took counsel’s opinion to, as far as possible, satisfy ourselves that that would be the position. I guess we always knew that that may be contested by the ATO and therefore we were looking at both scenarios. We were pointing out to the board what might happen in the worst case.
He acceded to the proposition that the difference between $17m and $133m was either getting the roll-over relief or not getting the roll-over relief.
On 17 April 2002 the Board of the applicant also had before it a document headed “Note to the Board” which contained a very brief comparison of the options which were then under consideration. Quite clearly, this short note dealt only with the most fundamental of factors involved in the various options. The note opened as follows:
The purpose of this note is to illustrate to the Board the key structural implications of each option regarding the possible sale of AXA Health as set out in the Board paper for April’s meeting.
It includes an opinion from Counsel. Given the “privileged” nature of this document we have deliberately separated it from the Board papers. Directors will find it helpful to reference this document during the presentation planned for the meeting.
It is clear from that passage, and from other parts of the note, that the Board had the advice of counsel about the matters under consideration. Again, a table showed the tax consequences of the options: the MBL proposal would involve the applicant paying anything from $118m to $139m less tax than the other options. According to the document, a feature of the MBL bid was –
The LBO structure takes advantage of the “scrip for scrip” Capital Gains Tax roll-over provisions. The effect of the structure is to defer CGT of $122m. The period of deferral is indefinite.
Although Mr Penn said that he could not recall the document, he accepted that the availability of the scrip-for-scrip roll-over provisions would have been covered in his presentation to the Board on 17 April 2002. The Board resolved that the bid from MBL should be progressed to the point of having a heads of agreement, and that MBF should be informed that it was no longer the preferred buyer (but also that negotiations with MBF should continue). From this point, the applicant and MBL proceeded to prepare the documentation necessary to give effect to the sale of AXA Health according to the revised bid of 16 April 2002.
Mr Lewis Culliver, the Group Tax Manager of the applicant, was present at Board meetings at which the proposal from MBL PTG was considered, and advised the Board in relation to taxation issues connected with it. In April and May 2002, he gave specific consideration to the requirements of the scrip-for-scrip roll-over relief provisions of the 1997 Act. He took advice, and thereby satisfied himself, that those requirements would be met in the transaction being proposed. He does not now recall giving specific consideration to whether MHA would be an ultimate holding company, but he said (in his evidence) that “it was always the case that [MHA] would not be a wholly owned subsidiary of the Macquarie Group”. He accepted that he was looking closely at the requirements of s 124–780 of the 1997 Act in April and May 2002.
By this stage, all of the potential members of an equity consortium previously identified by MBL, save BUPA, had lost interest. On 18 April 2002, Mr Julian Davies, Director Corporate Finance of BUPA, wrote to Mr Facioni to confirm (“so far as I can”) BUPA’s participation in the equity consortium to acquire AXA Health, adding “and indeed to the possible acquisition of the entire share capital” of AXA Health. He said that he and Mr Holden had “had a succession of discussions and followed the due diligence process in detail”. He said that they (Mr Holden and himself) were “fully supportive of the proposed bid valuing [AXA Health] at A$560 million subject to the terms and conditions set out in your bid document”. Mr Davies said that he did not then have the approval of the BUPA Board to participate in the bid, but the terms of his letter made it clear that he expected that approval to be forthcoming. He concluded by saying that funding was available and that, “indicatively although not contractually”, that funding would be sufficient for the acquisition of a 47% stake in the consortium.
In April 2002, the applicant was concerned to ensure that MBL PTG not on-sell AXA Health to BUPA alone without itself participating substantially in any profit arising from such a transaction. This concern was amongst a number of things discussed at a meeting on 29 April 2002 between representatives of MBL PTG, BUPA and MBL Advisory (representing the interests of the applicant) which was, in my perception of it, important, if for no other reason because it seems to have been the first occasion upon which such a tripartite coming together had occurred in the context of the applicant’s attempts to sell AXA Health.
Mr John Green (from MBL Advisory) opened the meeting by summarising the background to BUPA’s level of involvement in the proposed LBO. Then the BUPA representatives said that they were very serious. There was to be a BUPA Board meeting on 9 May 2002 to give formal approval to participation in the LBO, as to which no problems were anticipated. The representatives said that they had had “first class” access to the management of AXA Health, and that they had found “strong cultural similarities and similar ways of doing business”. They referred to other recent acquisitions by BUPA. They said that BUPA’s first acquisition in this region had to be “a really strong business” and that BUPA was keen to have a base in the region from which to approach other opportunities. They said that funding was not a concern. After some discussion of the possibility of a sale to MBF, the applicant’s concern about the potential embarrassment that might arise if AXA Health were on-sold by way of an IPO at a profit, or were effectively sold to BUPA, was raised by the representatives of MBL Advisory. As recorded in the minutes of the meeting, the response of the BUPA representatives was:
-BUPA are very much a long term player in market
-BUPA’s capacity to act earlier in year was limited but its appetite to participate has been increasing and hence the increased equity stake, and preparedness to continue in consortium whilst others have dropped out.
However, the BUPA representatives did not go so far as to say that they were contemplating an outright acquisition of AXA Health.
On 7 May 2002 Mr Owen sent an email to Mr Green in which he said that he understood that BUPA was “getting more excited and [was] taking a larger equity stake”. He said that the applicant would “not be at all happy” if a trade sale to BUPA took place. He said of BUPA: “…if they are changing their position on their interest in the whole business I think we should be talking to them direct”. Mr Green replied on 8 May 2002. He referred to the history of BUPA’s involvement in the consortium, and said that, at the meeting “a week or so ago” (which I infer was the meeting of 29 April 2002), there was no indication that BUPA would acquire 100% of AXA Health. Mr Green’s email continued (and concluded) as follows:
- The news yesterday that BUPA has offered Macquarie a put option over a proportion of Macquarie’s stake in AXA Health (taking MBL down to a $50m exposure as I understand it) is something that was also news to us and needs to be explored to AXA’s satisfaction.
- Bear in mind that it is in the context of Macquarie Bank now taking 50% of the equity (with Bupa alone the other equity player). ie because of the withdrawal of other equity, the MBL and Bupa positions have each increased to $112.5m, an amount of equity beyond Macquarie’s expressed ‘natural’ position of $50m.
- I see a put in two ways here:
- 1 it could be a positive for AXA if it keeps the bid alive by giving Macquarie Bank sufficient comfort that its exposure is ultimately limited to its comfort level of equity (before it seeks further institutional investors). Please tell me if you disagree.
- 2 BUT, to my thinking it may depend on the terms of the put. If Macquarie is covering downside and it is not a closet method of selling to Bupa, that is one thing. If it is a way for Macquarie to sell to Bupa and realise further profit, that is quite another. (I note that you have been assured before that a trade sale to Bupa is not the intention.)
- Mark and I are also taking up the issues as to BUPA’s current level of interest and the put terms with the Huey team this morning and will revert to you.
- We also believe that a way to address this may be for Huey to agree that if there is any sale to Bupa in the short term that AXA gets the lion’s share of benefit of it if it is as a profit
In his affidavit affirmed on 8 December 2008, Mr Green said that he could not recall any subsequent conversations on this subject. Neither could Mr Owen.
The process of drafting a heads of agreement was the responsibility of the applicant, and its solicitors produced a first draft on 3 May 2002. The parties to the agreement were to be the applicant, MBL, MHA and MHH. Sections of the draft set out the warranties that were to be given by the applicant and MBL. The only one presently necessary to mention is the following, to be given by MBL:
[I]mmediately prior to Completion:
(1)the issued share capital of MHA will comprise 100 ordinary shares and 65 million RPS;
(2)99 ordinary shares of MHA and all the RPS will be legally and beneficially owned by MBL and one ordinary share of MHA will be legally and beneficially owned by MHH;
In a mark-up of that draft done on 7 May 2002, MBL’s solicitors deleted the reference to “99” and to the one share to be held by MHH, and converted the provision into a requirement that all the shares in MHH be held by MBL or a “related party”, defined so as to include a company that was controlled by MBL. However, in the second draft prepared by the applicant’s solicitors on 10 May 2002, the original wording was restored, and that wording was thereafter retained.
On 8 May 2002, Mr Bob Herbert, an executive within MBL who worked with Mr Upfold, sent an email to many others (within MBL) including Mr Facioni and Mr Andrew McWhinnie, an Executive Director of MBL and head of its taxation division. It attached a draft of a transaction description by which AXA Health was to be acquired. It is an important document, as it set out compendiously, yet in some detail, a description of the whole arrangement, including aspects which had been negotiated with the applicant and aspects that had been negotiated with BUPA.
Mr Herbert’s draft said that prior to “announcement”, MBL would establish “the following acquisition structure to facilitate a scrip-for-scrip bid for AXA Health”. The following diagram was set out:
The details of the companies and relationships in the diagram were explained. It was said the “individual” referred to was to be an “unrelated individual (expected to be a partner of Blake Dawson Waldron, [MBL’s] legal advisers)”. The structure would be capitalised by MBL (through MHH) subscribing for 65,000,000 $1 redeemable preference shares in MHA. The funding of that was to be assisted by an interest-free capital injection of $35m by BUPA.
According to the draft, at “financial close” FundCo would enter into a sale and purchase agreement under which it would acquire all the shares in AXA Health for a price of at least $560m, consisting of $65m paid in cash and $495m in convertible shares issued by MHA to the applicant. A further element of the consideration was that the applicant would have the right to share in any profit made on the on-sale of AXA Health by MHA.
The draft referred next to the means by which MBL would sell down its interest in AXA Health. There was to be a consortium constituted by a company (“NewCo”) owned 50/50 by MBL and BUPA. MHA would on-sell its shareholding in FundCo (and thereby its recently-acquired interest in AXA Health) to NewCo. The arrangements made as between MBL and BUPA were described as follows:
Macquarie has entered into arrangements with BUPA governing the equity and debt contributions of the Consortium to reduce Macquarie’s initial exposure to AXA Health.
Prior to announcement, Macquarie and BUPA will execute the [Equity Participation Agreement (“EPA”)]. The EPA will legally bind BUPA to sub-underwrite $120 million of the equity (being 50% of total equity) in the Consortium. BUPA will also grant Macquarie a put option over $70 million of Macquarie’s equity with an exercise price of $70 million (“Macquarie Put”). The Macquarie Put will expire within 6 months from financial close.
This leaves Macquarie with an equity risk exposure of $50 million and a risk on BUPA’s performance of $190 million. This BUPA performance exposure will be secured by a letter of credit from HSBC or similar financier prior to Financial Close. Due to the importance of BUPA to the Consortium, Appendix 1 [to the proposition summary] sets out some information about BUPA.
Macquarie will grant BUPA a pre-emptive right (“BUPA Pre-emptive Right”) to acquire the remaining equity held by Macquarie (ie the $50 million in the event that the Macquarie Put has been exercised or Macquarie sells to institutional investors and $120 million in the event that it has not). The BUPA Pre-emptive Right will be exercisable for market value at the earlier of:
-the Consortium proceeding with an IPO; or
-18 months after Financial Close.
Macquarie will grant BUPA a call option (“BUPA Call”) over Macquarie’s residual $50 million exposure. The BUPA Call will have an exercise price of $60 million and will expire six months from the financial close.
Thus it will be seen that MBL’s maximum net exposure was $50m, but it was contemplated, but not then agreed, that BUPA would call for MBL’s residual interest in NewCo which represented that exposure.
Mr Herbert wrote another memorandum on 8 May 2002, this time jointly with Mr Greg Pahek, another executive who worked with Mr Upfold. Mr McWhinnie was one of the recipients. The purpose of the memorandum was to seek approval for the establishment of three special purpose companies required for the transaction which, as was then contemplated, would involve the acquisition of AXA Health. The first was MHH. Of its 100 ordinary shares, 99 were to be held by MBL and one was held by BDW Nominees Pty Ltd, a special purpose holding company owned by the partners of MBL’s legal advisers, Blake Dawson Waldron. The second was MHA. Of its 100 ordinary shares, 99 were to be held by MBL and one was to be held by MHH. The third was Macquarie Health Funding Pty Ltd (“MHF”), which was to be wholly-owned by MHA. The memorandum contained the same diagram as was set out in the email of the same date (see par 45 above), save that “Individual” had been replaced by “BDW Co” and “FundCo” had been replaced by “MHF”. On 10 May 2002, those companies were incorporated as requested.
Mr McWhinnie said that the memorandum from Messrs Herbert and Pahek was his first written notification of the intended structure of the MBL side of the entities proposed to be involved in the acquisition of AXA Health. He gave no evidence about, and was not asked about, Mr Herbert’s email, but it is a fair inference that he read that also on 8 May 2002. He said that, in the first half of 2002, one of the principal matters engaging his attention was the proposed introduction of the tax consolidation regime, which was eventually introduced in October of that year with effect from 1 July 2002. The regime would have allowed a wholly-owned group of companies to elect to be treated as a single taxpayer for income tax purposes. In February 2002, an exposure draft of the legislation had been released, and it had been announced that it would take effect from 1 July. In his affidavit affirmed on 10 September 2009, Mr McWhinnie continued:
One of the key consolidation issues that I was considering in and after February 2002, was the treatment of entities upon the formation of (or upon joining) a tax consolidated group. Because the ownership structure of a subsidiary member would be ignored, and the head company would be treated as if it were the owner of the subsidiary member’s assets, the tax cost of those assets would need to be ascertained. It was proposed that for the entities joining a pre-existing group the tax value of assets would be “reset”, effectively by attributing the costs to the head company of its interest in the subsidiary entity across the assets of that subsidiary entity. This method of determining the tax cost of a subsidiary member’s assets is commonly described as a “push down” of the head company’s ownership costs. On the other hand, if an entity entered a consolidated group upon formation it was permissible for the head entity to adopt the entity’s pre-existing tax values. I recognise that the ascertaining of the tax cost of an entity’s assets upon its entry into a tax consolidated group could be an administratively burdensome process involving external valuation costs. I was also mindful that the calculations required upon the exit of a member from a consolidated group could be equally administratively burdensome and expensive (these calculations would be required to be done in order to calculate the amount of any gain or loss arising as a result of the company’s exit from the group).
One of the other issues of the consolidation regime which I was considering at around that time was the liability of subsidiary members and former subsidiary members of a consolidated group for the tax debts of the entire group. One of the effects of the proposed legislation was that a member of a consolidated group would be jointly and severally liable for the tax debts of the group as a whole in circumstances where those debts were not met by the head company by the time they became due and payable. In effect, this meant that an entity which had left a group could still be held liable for the group’s unpaid tax debts to the extent that those debts were incurred while it was a member of the group. While joint and several liability is now managed through the implementation of tax sharing agreements, which have the effect of displacing the general rule, prior to the introduction of the consolidation regime tax sharing agreements had not been tested and their operation and effect was generally unknown. The prospect of ongoing joint and several liability issues was expected to further complicate the exit of entities from consolidated groups.
Mr McWhinnie said that MBL had decided to consolidate its group for tax purposes with effect from 1 October 2002 (the commencement of its 2002/2003 substituted accounting period). Mr McWhinnie was not involved in the early development of the proposals for the acquisition of AXA Health by MBL. When he received the memorandum of 8 May 2002 in which the proposal was explained in outline, he turned his mind to the question whether the incorporation of special purpose companies with the shareholding then proposed would give rise to any significant tax risks, particularly from a consolidation perspective. He concluded that it would not do so. Because MHA would not be owned 100% by MBL, Mr McWhinnie was satisfied that it would not form part of the consolidated group.
Although not specifically referred to in the evidence, I infer that the Board of BUPA did give approval to participation in the MBL consortium at its meeting on 9 May 2002.
By 16 May 2002, the heads of agreement being prepared by the applicant’s solicitors had reached its fourth draft. Of the drafts in evidence, that was the first to contain the subject of “Consolidation” amongst the warranties to be given by the applicant (but I note that the text contains mark-up, from which I infer that the subject had been introduced in the third draft). By these warranties, the applicant undertook not to make any choice or election that had the effect of causing AXA Health to be a member of a consolidated group for the purposes of the 1936 Act or the 1997 Act. It was also as a result of this (fourth) draft that the heads of agreement came to be called the “Underwriting Agreement”.
On 19 May 2002, a sixth draft of the Underwriting Agreement was prepared. On 20 May 2002, this was marked up by MBL’s solicitors, thereby becoming the seventh draft. No changes to the warranties to be given by the applicant were then made, but a new warranty was to be given by MBL in the following terms:
MHH will not be a wholly-owned subsidiary of MBL either at Completion or at any time whilst MHH owns ordinary shares in MHA.
Mr Culliver said that this provision was inserted on his insistence. In his affidavit sworn on 10 September 2009, he said:
I insisted that the warranty be included in the transaction documents because I was concerned about the implications that the proposed tax consolidation regime may have on the Applicant’s interest in AXA Health in the event that MBL was unsuccessful in its attempts to on-sell AXA Health and the Applicant decided to regain ownership of the company (by converting its vendor shares in MHA and exercising its call options). At the time, the Federal Government had announced that the tax consolidation regime would be introduced with effect from 1 July 2002, and that on and from that date the parent company of a wholly owned group would be able to elect to form a tax consolidated group irrespective of its accounting period. While the introduction date of the new regime had been announced, it was far from clear what form the provisions would ultimately take or what consequences they would have for the purchasers of companies that were members of such groups. At the time I recall that I was aware that there were concerns held generally among tax professionals that companies exiting a consolidated group would remain jointly and severally liable for the tax debts of their former group after the leaving time. Adding to this concern, and to the general uncertainty around the operation of the provisions, was the fact that an election to form a tax consolidated group could be made retrospectively or with effect from an earlier date. This meant that the purchaser of a wholly owned company of a consolidatable group faced the prospect of having the tax attributes of the company significantly altered as a result of an election being made following completion of the acquisition.
In the context of the LBO, I was mindful of the possibility that through the exercise of its rights attaching to the vendor shares and the call options, the Applicant may end up as the owner of MHA. MHA would hold significant assets, being either the proceeds of the on-sale of AXA Health or the shares in AXA Health. At the time I was concerned that if that happened and MHA had been a wholly owned subsidiary of MBL during the underwriting period, then an election by MBL to form a tax consolidated group from a date within that period could cause MHA and its wholly owned subsidiary, AXA Health, to become members of the MBL tax consolidate group. In that case, MHA and AXA Health, if it had not then been on-sold, would have been leaving members of the MBL tax consolidated group upon MHA ceasing to be a wholly owned subsidiary of MBL. I wanted to ensure that this could not occur. It was for that reason that I sought the warranty referred to above. That warranty together with the changes to the constitution of MHA required by the Underwriting Agreement and the terms of the vendor shares (refer to Schedule 3 of the Underwriting Agreement) meant that without the consent of the Applicant, MHA could not become a wholly owned subsidiary of MBL for the entire underwriting period. With that warranty I was satisfied that there could be no circumstances in which a transaction contemplated by the Underwriting Agreement would fall within the proposed tax consolidation regime.
Mr Culliver was cross-examined on this evidence. It was put to him that the purpose of this new warranty in the seventh draft was to ensure that the ultimate holding company requirement in the scrip-for-scrip roll-over relief provisions was satisfied. He denied it. He said:
This was one instruction that I gave to have in [the agreement] to cover the tax consolidation issue. This was a warranty that ensured that Macquarie Health Acquisitions maintained its financial condition and its governance during the underwriting period. It had nothing to do with scrip-for-scrip rollover.
On 22 May 2002, MBL and BUPA Australia Pty Ltd (“BAPL”) (the wholly-owned subsidiary of BUPA) procured the incorporation of a company called MB Health Holdings Pty Ltd (“MB Health”). It was jointly owned by MBL and BAPL. It was to be the entity referred to in Mr Herbert’s draft as “NewCo”.
By 22 May 2002, the price being offered by MBL had risen to a total of $595m, made up of a deposit of $57.6m and vendor shares in MHA to the value of $537.4m. Meanwhile, the applicant continued to deal with MBF as a possible, although no longer the preferred, buyer.
On 27 May 2002, Mr Facioni put the proposal for the acquisition of AXA Health to senior executives in MBL for approval. It was proposed that MBL would enter into the following transactions:
(a)a binding conditional underwriting agreement with the applicant;
(b)a binding equity participation agreement with BUPA and BAPL;
(c)two put options granted by BAPL to MBL, and one call option granted by MBL to BAPL, the net effect of which was to reduce MBL’s gross equity exposure (before fees) to $20m plus “contingent acquisition exposures”; and
(d)credit-approved commitments from two named banks.
Mr Facioni’s proposal explained that the overall transaction would be undertaken in four stages, namely, the establishment of the transaction entities (which had already been done), the announcement of the transaction, what was called “financial close” (about August 2002) and completion (about February-April 2003). The entities which would participate in the transaction were represented as follows:
The one share owned by BDW Nominees Pty Ltd in MHH made the latter a non-wholly owned subsidiary of MBL controlled by MBL. The entity called “Fundco”, which would actually acquire the applicant’s shares in AXA Health, was MHF. The entity called “NewCo” was MB Health. Its role would be to acquire AXA health either by the exercise of a put option by the applicant to provide the applicant with a “fallback” method of completing the sale of AXA Health, or, in the event that that option were not exercised, by the acquisition of MHF from MHA. MB Health would also have the task of raising debt funding from the banks, and equity funding from MBL and BAPL, to fund the acquisition of AXA Health.
There were, of course, many other elements to the proposal put by Mr Facioni to the executives of MBL on 27 May 2002. A number of them are disclosed in the documents executed as between MBL and the applicant on 4 June 2002, to which I refer below. Others of them related to MBL’s own financing of the proposed transactions, to its risk and benefit analyses and to the interface between MBL and BUPA (and BAPL). It is not necessary to refer to them here. The executives approved the proposal, subject to 14 conditions, one of which (insisted on by Mr McWhinnie) was “receipt of all tax advices in final in accordance with verbal indications/drafts”.
On 30 May 2002, MBL, BAPL, MB Health and BUPA entered into an “Equity Participation Agreement”. The recitals referred to the Underwriting Agreement which was then shortly to be executed as between MBL and the applicant, and noted that MBL and BAPL had agreed to establish a consortium to own and operate AXA Health, and had established MB Health as the “vehicle” through which they would do so. A central term of the agreement was the following:
Subject to the terms of this document, Macquarie and BAPL establish themselves as a consortium to complete the Consortium Acquisition and for the other purposes described in this document.
The term “Consortium Acquisition” was defined as:
(a)if the Vendor Put Option is not exercised, the acquisition by MB Health of 100% of the issued shares in Fundco, subject to Fundco having been since MHA Close, the legal, equitable and beneficial owner of 100% of the issued shares in AXA Health and otherwise on the terms set out in the Consortium Acquisition Agreement; or
(b)if the Vendor Put Option is exercised, the acquisition by MB Health of 100% of the issued shares in MHA, subject to MHA having been since MHA Close, the legal, equitable and beneficial owner of 100% of the issued shares in Fundco and Funco having been since MHA Close, the legal, equitable and beneficial owner of 100% of the issued shares in AXA Health and otherwise on the terms of the Vendor Put Option and the MHA Acquisition Agreement.
The agreement defined “MHA Close” as “completion under the Underwriting Agreement” (as to which, see para 66 below). The “vendor put option” was the put option proposed to be granted to the applicant under the Underwriting Agreement in relation to its shares in MHA. By the Equity Participation Agreement, MB Health agreed to be nominated by MBL to grant that option.
In the Equity Participation Agreement, the “Interests” of the consortium members were identified as 50% for each of MBL and BAPL. That reflected their then shareholding in MB Health, the consortium vehicle. The word “Interest” was defined as:
… the agglomeration of interests and rights subject to the obligations and liabilities to or by which each of the Consortium Members is entitled or bound under this document, expressed as a percentage of 100% ownership. With effect from completion of the Consortium Acquisition, the Interests of the Consortium Members will be reflected in their respective holdings of MB Health Shares.
The interests of the consortium members were to be adjusted to take account of factors which included “any sell-down” by MBL under the agreement. As to that aspect, the agreement provided:
Macquarie, as a financial investor, intends to reduce its Equity Share by the Settlement Date. It may do this:
(a)by exercise of its put Options under clauses 11.1 and 11.3 (or as a result of exercise by BAPL of its call Option under clause 11.2); or
(b)by introducing additional financial investors (who are not Industry Participants) to the Consortium.
As the provisions just set out suggested, the Equity Participation Agreement provided for two put options (granted by BAPL to MBL) and for one call option (granted by MBL to BAPL) in relation to MBL’s shareholding in MB Health. Of those options, Mr Facioni said (in his affidavit sworn on 8 December 2008):
Under the restated EPA, BAPL granted MBL two put options and MBL granted BAPL a call option and certain pre-emptive rights. The put options allowed MBL to sell its shares in MB Health to BAPL at a discount. The first put option allowed MBL to sell approximately 60 per cent of its shares in MB Health at a discount. The second put option allowed MBL to sell the remaining 40 per cent of its shares in MB Health at a greater discount.
In the event that an IPO of AXA Health or other divestment option could not be achieved, MBL could, by exercising its put options, sell its interest in MB Health to BAPL at a pre-determined maximum loss. In the same circumstances, BAPL could, by exercising its call option, buy MBL’s interest in MB Health at a pre-determined price which would generate a profit to MBL. If an IPO could be achieved, the pre-emptive rights would allow BAPL to acquire MBL’s interest in MB Health (and thereby AXA Health) at a price set by reference to a broker valuation of the IPO.
The Commissioner identified the counterfactual in the following terms:
If the taxpayer had not entered into the scheme, it would have disposed of AXA Health directly to MB Health, a company jointly owned by MBL and British United Provident Association Limited (BUPA).
Particulars of Sale to MB Health
1.On 9 May 2002 the Board of Directors of BUPA (a UK health insurer and foreign investor) decided to proceed with the acquisition of AXA Health, either directly or though an Australian holding company and either as sole purchaser or as a member of a consortium that included MBL.
2.On 30 May 2002 MBL, BUPA, BUPA’s Australian subsidiary, BUPA Australia Pty Limited (BAPL) and MB Health entered into the Equity Participation Agreement for the purchase of AXA Health by MB Health.
3.Under the Equity Participation Agreement MBL and BUPA granted each other two put options and a call option over their shares in MB Health (refer clause 11 of the Equity Participation Agreement and related schedules). The put and call options equated to a forward purchase of AXA Health by MB Health.
4.On or about 1 July 2002 BUPA (being a foreign company) requested the Foreign Investment Review Board for approval for MB Health to acquire AXA Health and the Foreign Investment Review Board granted such approved in or about August 2002.
5.Under the Shareholders Deed dated 25 August 2002 between MBL, BAPL, MB Health and BUPA, AXA Health and MHF were treated as subsidiaries of MB Health from the date of MHF’s acquisition of AXA Health. As part of this agreement, from the date of the MHA acquisition of AXA Health the board of directors of AXA Health and MHF were the same as that of MB Health.
6.From the date of MHF’s acquisition of AXA Health, MB Health took over the management of AXA Health.
7.At no time was MBL exposed to the risks and rewards associated with ownership of AXA Health.
In his Outline of Submissions filed three working days before the commencement of the trial, the Commissioner relied on the scheme identified in his appeal statement. He did, however, then propose two counterfactuals, namely:
a.the taxpayer would have sold AXA Health directly to MB Health/BUPA for $570m;
b.alternatively, the taxpayer would nonetheless have sold to MBL for on-sale to MB Health/BUPA involving as it did the share exchange, but without those features that had no commercial rationale – viz: the de-grouping of MHA from the MBL group and the less than 30% voting rights attaching to the replacement shares.
At trial, the Commissioner did not lead any witness evidence, but tendered some documents after the applicant’s case had been closed. Although the significance of those documents was explained, there was no opening by counsel for the Commissioner. Counsel for the applicant addressed first. Counsel for the Commissioner commenced their address on the morning of the fifth day. In the course of that address, counsel submitted that there was a scheme as identified in the Commissioner’s appeal statement. They sought leave to rely also, and in the alternative, upon narrower schemes identified as follows:
·the steps leading up to and including the share exchange, plus the conversion of the applicant’s vendor shares in MHA and the exercise by the applicant of the call options with respect to the ordinary shares in MHA held by MBL and MHH;
·the interposition of MHH between MBL and MHA, and the issue of one share in MHH to BDW Nominees Pty Ltd.
Counsel for the Commissioner relied on the counterfactual set out in their client’s appeal statement, namely, a disposition of the shares in AXA Health to MB Health. In the course of their submissions, they sought leave to rely on a number of additional counterfactuals, each of which, it was said, might reasonably be expected to have taken place in the absence of the scheme, or one of the schemes, on which they relied. They submitted that, in the absence of the scheme or schemes –
·the applicant would have disposed of its AXA Health shares to MBL, either by direct sale or by share exchange, and MBL would have on-sold them to MB Health;
·the applicant would have disposed of its AXA Health shares directly to BUPA (or, presumably, to BAPL), either by direct sale or by share exchange; or
·the transaction would have proceeded exactly as it did, but without the existence of MHH (ie, with MBL owning 100% of MHA).
Although the applicant objected to leave being granted to the Commissioner in either of the respects referred to above, its counsel accepted that the first of the two alternative schemes proposed “does not appear to have any great practical consequences to it”. However, they submitted that, in other respects, the amended case proposed by the Commissioner would have practical consequences. In those respects, the applicant strongly resisted the granting of leave to amend, and did so on what were essentially procedural fairness grounds. Some time after I reserved judgment, and in the course of preparing these reasons, I came to the provisional view that the Commissioner ought be permitted to rely upon the second of his proposed alternative schemes, and upon the third of his proposed alternative counterfactuals, but only if that could be done without denying the applicant procedural fairness.
On 17 June 2009, my Associate communicated to the parties in terms which included the following:
His Honour is provisionally of the view that leave to rely upon the scheme, and the counterfactual, referred to should be granted, but only if that can be done without denying the applicant procedural fairness. In the circumstances, his Honour proposes that the parties should indicate, by memoranda filed within 14 days:
-whether the Commissioner accepts that to grant the leave which he seeks, and to decide the points upon which he seeks to rely on the merits, without giving the applicant an opportunity to call further evidence and/or to make further submissions would amount to a denial of procedural fairness;
-if that course would amount to a denial of procedural fairness, whether the case should nonetheless proceed to judgment as things stand, or whether the applicant should be given an opportunity to call further evidence and/or to make further submissions;
-if the applicant is to be given that opportunity, what form should that opportunity take, and what conditions (as to timing, costs and otherwise) should be imposed in relation thereto.
In their memoranda, the parties need not confine themselves to the above matters. The basic question is whether, if otherwise there would be a want of procedural fairness, that deficiency could and/or should be cured at this stage, and if so how, and on what terms.
In a memorandum filed on 15 July 2009, counsel for the Commissioner stated that her client sought to rely only on the scheme as set out in his Appeal Statement. It was made clear that the two alternatives advanced in oral submissions were not pressed. In the same memorandum, counsel sought to amend the Commissioner’s Appeal Statement by adding a further counterfactual, namely,
… in the absence of the scheme, it could reasonably be expected that the applicant would have disposed of AXA Health in the same way as it did, with MBL holding 100% of MHA.
In a Ruling given on 13 August 2009, I indicated that I would give the Commissioner leave to amend his Appeal Statement as sought, but I said:
The course I propose to take is the following. I shall grant the Commissioner leave to amend. I shall lay out a program for the filing and service of affidavits limited to the question whether, in the absence of the scheme, the applicant would have proceeded in accordance with the new counterfactual now relied on by the Commissioner. I shall fix a date for the hearing of that question. I shall, however, reserve to the applicant liberty to apply for the revocation of the leave to amend. I have in mind that if, after using all its best endeavours to call the evidence necessary to meet the Commissioner’s new counterfactual, the applicant finds itself unable to do so by reason of the passage of time, I would then be sympathetic to an application to revoke the leave I now grant to the Commissioner, and if I did revoke that leave, I would decide the case on the strength of the Commissioner’s Appeal Statement in its present form.
In the result, I sat again to receive the additional evidence which the applicant wished to lead in connection with the new counterfactual. The Commissioner also led some further documentary evidence. The applicant did apply, by notice of motion, to have the leave to amend revoked, but asserted no inability to make contact with the witnesses necessary to deal with the Commissioner’s amended case. The proceeding in its re-configured form was contested on the merits and, although the additional witnesses called by the applicant professed some difficulty in recalling events now more than seven years old, in the way I propose to dispose of this proceeding the applicant will not be disadvantaged merely by the circumstance that, as the party with the onus of proof, it was unable to lead the necessary evidence. I propose, therefore, to dismiss the applicant’s notice of motion.
The case now before me, therefore, involves a consideration of the scheme referred to in para 107 above, and of the counterfactuals referred to in paras 109 and 113. The applicant submitted that this was a case in which the Commissioner needed some kind of transaction by way of the sale of AXA Health for there to be any capital gains tax payable at all. It was not a case in which, if the scheme were stripped away, the counterfactual would be there for all to see (as might, most obviously, be the situation where a claim to a deduction is disallowed under Pt IVA). Here, the Commissioner needed to replace the presumptively eliminated scheme with some positive transaction, as indeed the Commissioner proposed in his counterfactuals.
At this point the applicant relied on Federal Commissioner of Taxation v Lenzo (2008) 167 FCR 255 in support of the proposition that the words of s 177C(1)(a) “if the scheme had not been entered into or carried out” do not permit consideration of a counterfactual in which part of the scheme is retained. In Lenzo, the Full Court was concerned with par (b) of the subsection, which deals with deductions. There was no dispute as to the definition of the scheme. However, it was contended on behalf of the taxpayer that, absent the scheme, he would nonetheless have entered into similar transactions which would have entitled him to a deduction of the same order as he achieved by reason of the scheme, and, therefore, that it could not be said that the deduction would not then have been allowable within the terms of s 177C(1)(b). Sackville J, who delivered the main judgment on this point, held first that what had to be assumed out of existence under the statute was the scheme as a whole, not a part of the scheme. His Honour then turned to the question whether the taxpayer had established that, notwithstanding the absence of the scheme, it ought reasonably be expected that the taxpayer would have entered into the other transactions to which I have referred. This raised issues of fact, upon which the taxpayer was assisted neither by the findings of the primary Judge nor by the state of the evidence. Sackville J said (167 FCR at 280-281 [133]-[135]):
Thirdly, the Court was not taken to evidence that would justify a finding that, in the absence of the scheme, the promoters of the Project would have been willing and able to invite investors to participate in it. Obviously, resolution of the factual issue would depend on the terms on which the Project might have been offered, but this is a matter of speculation.
In my view, Lenzo is authority for the proposition that the starting point under s 177C(1)(a) is one which the whole scheme identified by the Commissioner must be assumed out of existence. The question then arises: what then might reasonably have been expected to have been included in the assessable income of the taxpayer? Here the court is engaged in a “prediction as to events which would have taken place” in the absence of the scheme: Commissioner of Taxation v Peabody (1994) 181 CLR 359, 385. The exercise thus postulated, in my view, is wholly one of fact-finding. A fact is not disqualified, a priori as it were, from consideration merely by reason of it having been an element of the scheme which was in place. To the contrary: what the taxpayer and his or her associates in fact did in the commercial circumstances which existed is likely to shed much light on what they would have done in the absence of the scheme, and in some cases to be, as a matter of prediction, elements of that counterfactual. Nothing in Lenzo requires me to hold otherwise. Indeed, the way Sackville J approached the task of prediction was entirely consistent with the counterfactual in any particular case involving elements of the presumptively discarded scheme, assuming always that the facts of the case indicated such an outcome.
It was not seriously suggested on behalf of the applicant that the scheme identified by the Commissioner – effectively every element of the transaction and arrangements by which the sale of AXA Health was structured and carried out – was not a scheme as defined in s 177A. The real issue in this part of the case is what might reasonably be expected to have occurred in the absence of the scheme. Here the Commissioner proposed first that the applicant would have sold AXA Health directly to MB Health. For such an eventuality now to be regarded as a matter of reasonable expectation requires a consideration of how the applicant, MBL and BAPL would have acted in the absence of the scheme.
In his affidavit sworn on 14 November 2008, Mr Owen said that an offer directly from MB Health –
… would have given rise to different commercial considerations to the ones which were addressed by the MBL PTG offer. Among other things, timing issues, the inclusion of vendor finance, and the provision of security in relation to the payment of the purchase price would have required careful consideration and detailed review.
In chief, Mr Owen was asked whether, in the absence of the bid for AXA Health which was in fact made by MBL, the applicant would have sold that company (or its business) to MB Health. He responded:
Well, look, the reality of the situation is, I don’t recall – I’m not sure … I was aware at the time. I mean, Andy Penn did all the detailed negotiation. I mean, my concern at the time was to ensure that we could sell at an acceptable price, and with a number of protections, and at very, very low risk completion risk. And I’m not sure I concerned myself at the time – and I certainly don’t recall now – the detail of the structure that Macquarie Bank had put in place. So – yes. I can’t recall specifically the difference between – what was it, MB Health Holdings and – what was it, Macquarie Bank – MHA, yes, that’s right. I don’t think I can come at it any further on that one.
Under cross-examination, Mr Owen was asked whether, if, instead of using the acquisition structure that was devised by MBL, an offer had come to the applicant directly from MB Health “for the same headline price, with the proceeds payable in the same timeline and with acceptable security being offered in respect of the proceeds”, the applicant would have accepted such an offer. His response was:
The offer didn’t come and therefore that was not a consideration and so that’s a purely hypothetical question. I had always assumed that the structure from – I mean, Macquarie had their own objectives in relation to wanting to minimise their own balance sheet risk and to me the structure met their objectives and to the extent that they had objectives that was not our consideration. Our consideration was to look after our objectives. There never was an alternative offer, so we never considered what our view would be had there been one.
Notwithstanding the caution expressed in that response, Mr Owen made it clear that the applicant would have sold AXA Health for “an acceptable price and an acceptable set of conditions that gave [the applicant] a high degree of certainty of completion”. He said that the applicant “would have seriously considered alternative bids that gave us the same headline price and the same degree of security”. However, he stressed that the offer from MBL (in the terms that it contained) was the only one before the applicant capable of acceptance. Pressed to say whether the applicant would have sold to MB Health directly, Mr Owen said:
Well, it’s a purely hypothetical – I can’t say what we would have done in a hypothetical set of circumstances. We were not put in those circumstances and therefore, you know, I can’t answer the question.
Senior counsel for the Commissioner then asked Mr Owen whether the applicant would have accepted an offer, with the same headline price and the same degree of security, made directly by BUPA. He replied:
We would have seriously considered it subject again to the same thing I just said. Headline price is clearly very important, but so is the certainty of completion. So we would have seriously considered alternative offers. There weren’t any, as you will know from the papers. …. So again, I can only repeat: I can’t tell you what my view would have been of other offers that were never received.
From the tenor of this evidence, I would be prepared to find that it might reasonably be expected that, had an offer with the same headline price and the same certainty of completion been made by MB Health, the applicant would have accepted it. However, ought it reasonably be expected that, absent the scheme, such an offer would have been made, or that MB Health would have existed at all?
In his affidavit sworn on 8 December 2008, Mr Facioni said:
In the course of preparing this affidavit I have become aware that the respondent has suggested that if the Applicant had not sold AXA Health to MHA, it would have sold AXA Health directly to MB Health. That suggestion is incorrect. The transaction with the Applicant to purchase AXA Health had been originated, structured, negotiated and executed by MBL. MB Health, BUPA and BAPL were participants in the transaction, with MBL as the overall transaction sponsor. MBL stood to receive certain financial benefits for arranging and leading the transaction and for assuming certain material risks (financial and reputational) and devoting significant resources throughout the course of the transaction. At no time was MB Health in a position independently to offer to acquire AXA Health and, as a 50 per cent shareholder in MB Health with significant commercial benefit at stake, MBL would not have permitted such a transaction to occur.
Objection was taken to the final sentence in that extract. I deferred my ruling on that objection pending Mr Facioni being asked in chief what was the basis for the statement contained in that sentence. He was so asked, and responded as follows:
I was the transaction leader, so I was directing the transaction on behalf of Macquarie Bank and I was reporting through to Macquarie Bank’s executive committee and ultimately board of directors. The transaction had been arranged in a way that Macquarie stood to make quite significant economic benefits by virtue of how the transaction was anticipated to proceed; that is, AXA Health to be acquired by Macquarie Bank and then on-sold to a consortium. That was the nature of the transaction that we structured. That was how Macquarie Bank stood to make an economic benefit. If Macquarie Bank were to be bypassed in that sequence, it would sacrifice quite significant fees and it wasn’t in its interests for that to occur. So Macquarie Bank was highly incentivised to ensure that the transaction proceeded along those lines. I guess, further to that, MB Health itself had no resources, had no employees, had no financial resources, and was only able to ultimately acquire AXA Health through the work that Macquarie Bank and Macquarie Bank’s executives – being myself and the team – were conducting.
On the strength of that evidence, counsel for the Commissioner did not pursue their objection. Under cross-examination, Mr Facioni confirmed that the transactions which MBL negotiated with the applicant were separate from those which it negotiated with BUPA. He agreed that the “significant commercial benefit” to which he referred in the final sentence in the passage from his evidence set out above was the selldown fee of $5m provided for in the Equity Sell Down Agreement and the underwriting fee of $5m provided for in the Underwriting Agreement, adding “plus also any profits that [MBL] could make through an on-sale”. He was challenged about that latter aspect, and explained that, as at the time when the Underwriting Agreement was executed with the applicant on 4 June 2002, MBL had obtained a commitment from BUPA that it (or presumably BAPL) would take 100% of AXA Health if MB Health were not able in the meantime to sell it to third parties at a profit. It was only later, when no such third parties could be found, that it was agreed as between MBL and BUPA that the latter would assume complete ownership of MB Health (and, presumptively, of AXA Health).
I consider that the question whether it might reasonably be expected that MB Health would have made an offer to buy AXA Health directly from the applicant must be asked, notionally, at 3 June 2002, or some other point in time thereabouts when MBL and the BUPA interests had executed the Equity Participation Agreement but before the execution of the Underwriting Agreement. It was the latter that primarily set up the structure that was employed for the sale of AXA Health, a structure that could not be described as a direct sale from the applicant to MB Health. Put another way, the execution of the Underwriting Agreement necessary destroyed any prospect of a direct sale, thereby excluding it from the range of outcomes that might reasonably be expected to have occurred.
As at 3 June 2002, MBL had established a consortium for the acquisition of AXA Health. The vehicle for that was MB Health. MBL and BAPL each held 50% of the equity in that company. By a put option granted by BAPL, MBL knew that, if no better prospect arose, it would be able to sell its shareholding in MB Health to BAPL at an agreed price. The size of that price depended upon a formal valuation of AXA Health, the terms of which were agreed in the Equity Participation Agreement. However, MBL then (ie at 3 June 2002) held out at least the optimistic prospect that some greater return on the disposition of its interest in MB Health might be achievable, either by an IPO or by some other disposition of the interest. It would be wrong to conclude, therefore, that before the execution of the Underwriting Agreement it had been finally resolved as between MBL and BUPA that, one way or the other, BAPL would inevitably eventually hold 100% of the equity in MB Health. But these considerations, it seems to me, would all apply however AXA Health were transferred from the applicant to MB Health. The risk-taking, the potential for profit from the on-sale of MBL’s interest in MB Health and the security which was provided by the put option are all to be viewed, in my view, as consistent with a putative process in which the objective was for MB Health to acquire AXA Health directly from the applicant – no less than was the case under the events which in fact occurred. These considerations do not, therefore, count against the expectation for which the Commissioner contends.
The same conclusion cannot, in my view, be reached with respect to the position which MBL would occupy in its relations with the applicant, if it be assumed that there was to be a direct sale to MB Health. As I have pointed out above, it must be here assumed that there would have been no Underwriting Agreement. Thus MBL would have foregone the underwriting fee of $5m. Neither would the Equity Sell Down Agreement have made any sense under a direct sale scenario. There would, therefore, have been no equity sell down fee of $5m. Thus MBL itself would have been $10m the worse off for the absence of the mechanism by which AXA Health was sold indirectly to MB Health. Mr Facioni was adamant that MBL would never have made itself part of a direct acquisition of AXA Health by MB Health for the reason (at least) that it would not then derive this fee income. Although his apprehension that a direct sale would have denied MBL the prospect (which existed on 3 June 2002) of profiting from the on-sale of its interest in MB Health is not, I have found, a relevant point of difference between the two scenarios, I accept what he said about the loss of the fees to which I have referred. I therefore consider it to be outside the range of reasonable expectation that, if AXA Health had not been sold in the way that it was, it would have been sold directly by the applicant to MB Health at the same price.
The alternative contention of the Commissioner as to what might reasonably be expected to have happened in the absence of the scheme involved all the events and transactions which did occur, but with MBL holding 100% of MHA. On the Commissioner’s case, that would have disqualified MHA from status as an “ultimate holding company” for the purposes of s 124-780, with the result that the condition set out in subs (3)(c)(ii) thereof would not have been satisfied. As a matter of construction, the applicant did not accept that proposition, but the more important question is the factual one of what might reasonably be expected to have occurred if MHA had been a wholly-owned subsidiary of MBL.
Both of the main commercial parties involved in the sale of AXA Health – the applicant and MBL – were concerned about the risk of MHA being consolidated as an incident of the transactions that were proposed. Schedule 1 to the Underwriting Agreement as executed on 4 June 2007 contained the relevant protections against that eventuality which both sides sought. I am here concerned with the possibility that MHA might have become part of the MBL group on consolidation on 1 October 2002 (as was proposed at about the start of June that year). The applicant did not want that to happen. After the passages from Mr Culliver’s affidavit to which I have referred in para 52 above, he continued:
Had MBL made an offer to the Applicant for the acquisition of AXA Health in the same or substantially the same terms as it did, but with MHA as a wholly-owned subsidiary of MBL, I would have recommended to the board of directors of the Applicant that the offer not be accepted. Such an offer in the context of the proposed tax consolidation regime would have meant that the certainty and value to the Applicant of the security to be given to it in the form of the vendor shares and the call options would have been significantly undermined.
Mr Culliver was tested on this evidence when under cross-examination, but he maintained his position and, in my assessment of it, did so credibly. I accept his evidence that there might have been another way to avoid the consolidation problem, such as by extracting a warranty from MBL in the terms given by the applicant itself. He accepted that, if MBL had given an undertaking not to consolidate, “that would have resolved the issue”. However, the evidence is that, by mid-2002, MBL did propose to consolidate with effect from 1 October 2002 and, as I was informed (apparently uncontroversially), the new legislative provisions circulating in draft at that time would not have permitted a holding company to consolidate some but not all of its 100% subsidiaries.
In an affidavit sworn on 11 September 2009, Mr Allert said that, had Mr Culliver recommended that the offer from MBL not be accepted because of the risk of consolidation, he and the other members of the AXA Health sub-committee of the applicant’s Board would not have accepted the offer. That evidence was not challenged by the Commissioner.
On the MBL side, when Mr McWhinnie received the memorandum from Messrs Herbert and Pahek on 8 May 2002, he considered whether the proposed corporate structure would give rise to any significant tax risks, particularly from a consolidation perspective. Because of the small shareholding to be allotted to BDW Nominees Pty Ltd, he took the view that it would not. When he received Mr Facioni’s proposal of 27 May 2002, he again took the view that “tax consolidation or other issues or difficulties” would not be created, because MHH, MHA and MHF were not to be wholly-owned subsidiaries of MBL. In his affidavit of 10 September 2009, Mr McWhinnie continued:
Given the MBL group’s interest in consolidating from 1 October 2002, if the acquisition of AXA Health had been effected using wholly-owned vehicles, I would have been concerned based on the understanding of the proposed tax consolidated regime that I had when I reviewed the Proposition Summary, that MBL would be required to bring MHA (or whichever other entity held the shares in AXA Health) into the consolidated group. The tax implications of such consolidation/deconsolidation would have been substantial unless AXA Health could be acquired and on-sold before 1 October 2002. This was not what the Proposition Summary contemplated. I was not involved in the timing of the acquisition or on-sale. The issues may have been substantial because if AXA Health had been acquired prior to 1 October 2002, the tax values in respect of the AXA Health assets may have affected the tax values of the other assets of the MBL group and other members of the MBL group may have been liable for tax liabilities of AXA Health. If AXA Health had been acquired after 1 October 2002, then the inclusion of AXA Health in a pre-existing consolidated group would have required the burdensome process of re-setting the tax values of the AXA Health assets to be undertaken. This, and the fact that AXA Health may have been liable for tax liabilities of other members of the MBL group may have complicated any on-sale to a significant extent.
After considering various other aspects of the proposal, I gave my approval for the proposed transactions to be entered into because the consolidation of AXA Health was not a possibility under the proposed structure, by reason of the fact that the acquisition was to be effected using non-wholly owned vehicles. In the event, I understand that AXA Health was acquired in August 2002, with sale occurring approximately six months later. Whether or not the Applicant would be able to obtain scrip for scrip roll-over relief was of no concern to me and so far as I can recall, was not a matter that I particularly turned my mind to at the time. My focus was directed to identifying tax risks to MBL.
….Given the above, especially in the light of the complexity of AXA Health’s business, had it been proposed that the acquisition of AXA Health be undertaken using a vehicle or vehicles wholly-owned by MBL, it is most unlikely that I would have given my approval for either the incorporation of the special purpose companies or for the proposed transactions set out in the Proposition Summary. This was particularly the case in the circumstances given that the tax consolidation legislation was still pending.
Had wholly-owned companies been proposed, I would have discussed the ownership structure with the MBL executives responsible for formulating the transaction and with Mr Greg Ward, the Chief Financial Officer, and advised them of my concerns in relation to the tax consolidation issues discussed above and recommended that the transactions as proposed should not be entered into on that basis. Had I made such a recommendation, I consider that the use of wholly-owned vehicles would not have been accepted by MBL
Under cross examination, it was put to Mr McWhinnie that, once the vendor shares had been issued by MHA to the applicant, there was no prospect of consolidation. He replied:
I became aware of the vendor shares proposal at the end of May when I received the proposition summary. At that time, I had already approved the fortnight previously the incorporation of companies, which obviated the whole question.
It was put to Mr McWhinnie that, as at May 2002, the contemplation was that the vendor shares would be issued in August, and that MHA would not, even absent MHH, have been a wholly-owned subsidiary of MBL on the intended consolidation date, 1 October 2002. His response was that he could not “risk a delay”. He added that:
With respect to the vendor shares, experience tells us that the timeframes envisaged by deal teams are not always met, so therefore primary reliance cannot be placed – I didn’t place primary reliance on the deal team achieving a particular timeframe.
And later:
I couldn’t have justified to my superiors on our board, taking a risk of having wholly owned vehicles and telling them that the intended plans to consolidate on 1 October 2002 were in jeopardy because a deal team had failed to complete a transaction on time.
Although Mr McWhinnie accepted that the issue of the vendor shares, if done as proposed in August 2002, would have removed MHA from the consolidation proposed by MBL, he made it quite clear that in May 2002 he was relying primarily upon the 1% shareholding that lay outside the MBL Group as a basis for his own satisfaction that there would be no relevant consolidation risk. I accept that evidence, and Mr McWhinnie’s evidence that, absent that 1%, he would have recommended that the transactions not go ahead. He was not challenged on his evidence that, had he made such a recommendation, the use of wholly-owned vehicles would not have been accepted by MBL.
Although attention was drawn to the aspect of the matter to which I now refer neither by counsel nor by Mr McWhinnie, as it happens he had every reason to be cautious about the prospect of the vendor shares being issued to the applicant before MBL’s consolidation date of 1 October 2002. As noted in para 64 above, on 4 June 2002 the Underwriting Agreement required the vendor shares to be issued on “Completion”, which was defined as the latest of three dates, one of which was 31 August 2002, but another of which was 20 days after the execution of the “transaction documents”. Clause 3.2 of the Underwriting Agreement required the parties to use their “reasonable endeavours” to negotiate and to enter into the transaction documents on or before 7 August 2002. If that was not achieved, the dispute resolution procedure to which I referred in para 63 was required to be invoked. Depending on how things might have gone under that procedure, one possibility was that the mediator’s determination would not be made until 4 October 2002, and the transaction documents would not be executed in the form required by the mediator until 11 October 2002. That is to say, the Underwriting Agreement, in the form it took on 4 June 2002, left open the possibility that the vendor shares might not be issued until 11 October 2002. By then, MBL would have consolidated its group. Properly advised, and taking a no-risks approach to matters, Mr McWhinnie would, in my estimation, have had every reason to insist that there was some other, ideally structural, ingredient of the proposed transaction that insulated MBL from the risk of having MHA, and thereby AXA Health, included as part of its consolidated group.
In final submissions, counsel for the Commissioner submitted that I should take the view that MBL had no reason to be worried about the consolidation of MHA, even if the vendor shares were not issued until some short time after 1 October 2002, since MHA would, in that intervening period, have been no more than a $100 company the presence of which in the MBL accounts could have been of no practical significance. This submission was based on the silent proposition that, once the vendor shares were issued and MHA was no longer wholly-owned by MBL, it would, ipso facto as it were, be deconsolidated. The legal and accounting supports for this proposition were assumed rather than articulated, and when I drew this to the attention of counsel for the Commissioner, they proposed that they should investigate the matter and give me the benefit of a further memorandum on the subject, after I had (again) reserved judgment. I did not encourage such a process, as it would, almost inevitably, have led to further forensic contention about the interface between laws which might have applied in a hypothetical situation which never existed and the ways in which the parties might reasonably be expected to have reacted to those laws and to the facts then confronting them. The more significant problem with this submission on behalf of the Commissioner is that the scenario was not put to Mr McWhinnie. There may have been a very good answer to the question whether the short-term existence of MHA as a $100 company in the MBL consolidated accounts would have given rise to accounting or financial issues which MBL would want to avoid. Mr McWhinnie was not given the opportunity to provide that answer. While he was in the witness box, the evidence in par 15 of his affidavit, set out at para 129 above, went largely unchallenged. I am obliged to accept that evidence, and to approach the matter of reasonable expectation under s 177C(1)(a) of the 1936 Act by reference to it.
Earlier in these reasons, I have found that the need to satisfy the scrip-for-scrip roll-over provisions of the 1997 Act was a reason – possibly the reason – why it was originally intended that MHA would not be a wholly-owned subsidiary of MBL. However, by the time MHA came to be incorporated, the intended shareholding structure was recognised (by Mr McWhinnie) as meeting a further purpose, which he regarded as important. At least as significant for present purposes was Mr Culliver’s insistence, on about 20 May 2002, that MBL provide a warranty that MHH would not be a wholly-owned subsidiary of MBL. No doubt he recognised the part which the structure of MHH would play under s 124-780, but he also insisted on a maintenance of that structure for other reasons which I should regard as valid and legitimate.
I accept the evidence called on behalf of the applicant that, if MHA had been a wholly-owned subsidiary of MBL, the transaction would not have taken place in respects which were otherwise the same as those which did obtain in the period May-August 2002. I reject, therefore, the Commissioner’s alternative counterfactual that it might reasonably have been expected that, in the absence of the scheme, MHA would have been a wholly-owned subsidiary of MBL but that, in other respects, the same transactions would have taken place. I hold, for the purposes of s 177C(1)(a) of the 1936 Act, that there is no amount that would have been included, or might reasonably be expected to have been included, in the assessable income of the applicant − being an amount that was not otherwise part of that assessable income − if the scheme identified by the Commissioner had not been entered into or carried out. I would, therefore, uphold the applicant’s challenge to the Commissioner’s determination under s 177F of the 1936 Act.
The applicant made a number of alternative submissions to the effect that, even if the same transactions had occurred with MHA being a wholly-owned subsidiary of MBL, it would still have been entitled to scrip-for-scrip roll-over relief. In the circumstances, the questions raised by these submissions, which were of some complexity, involving, as they did, a consideration of the application of the 1997 Act to events which did not happen, do not need to be addressed. Neither am I called upon to consider the application of s 177C(2)(a) of the 1936 Act, upon which the applicant also relied.
DISPOSITION OF THE PROCEEDING
For the foregoing reasons, I consider that the appeal should be allowed, and that the applicant should be assessed for income tax in respect of the substituted year ended 31 December 2002 on the basis of an entitlement to scrip-for-scrip roll-over relief as provided for in Subdiv 124-M of the 1997 Act, and in the absence of a disentitling determination under s 177F of the 1936 Act. I shall hear the parties as to the terms of the orders necessary to give effect to these conclusions, and with respect to costs.
I certify that the preceding one hundred and thirty-six (136) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Jessup. Associate:
Dated: 4 December 2009
Counsel for the Applicant: Mr G R Davies QC and Mr A T Broadfoot Solicitor for the Applicant: Mallesons Stephen Jaques Counsel for the Respondent: Ms J Davies SC, Mr M Moshinsky SC, Mr K Pose and Ms D Mandie Solicitor for the Respondent: Australian Government Solicitor
Date of Hearing: 23 - 27 March, 13 August and 22 October 2009 Date of Judgment: 4 December 2009
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