BHP Billiton Finance Ltd v Federal Commissioner of Taxation
[2009] FCA 276
•30 March 2009
FEDERAL COURT OF AUSTRALIA
BHP Billiton Finance Limited v Commissioner of Taxation [2009] FCA 276
TAXATION – deductions – bad debt claims – business of lending money – conduct undertaken in the ordinary course of business of lending money – taxpayer, internal financier to a group of companies – Income Tax Assessment Act 1997 (Cth), ss 25-35(1)(b), (1)(a), 8-1
TAXATION – Commissioner’s power to made a determination under s 177F without issuing an assessment – Income Tax Assessment Act 1936 (Cth), s 169A
TAXATION – Income Tax Assessment Act 1936 (Cth), Part IVA
TAXATION – limited recourse debt – debt property in limited recourse debt – Income Tax Assessment Act 1997 (Cth), Div 243
Corporations Act 2001 (Cth) ss 18-21, 45A, 119, 124, 125, 555, 1305, 1306
Financial Institutions Duty Act 1982 (Vic)
Income Tax Assessment Act 1936 (Cth) ss 6-1, 99A, 166A, 169A(3), 177F, 177G, Pt IVA, sch 2C div 245
Income Tax Assessment Act 1997 (Cth) ss 8-1, 25-35, 995-1, div 40, div 243, div 974, Pt 3-90
Taxation Administration Act 1953 (Cth) ss 14ZZ, 14ZZOAGC (Advances) Ltd v Federal Commissioner of Taxation (1975) 132 CLR 175
Agricultural and Rural Finance Pty Ltd v Gardiner (2008) 251 ALR 322
American Leaf Blending Co Sdn Bhd v Director-General of Inland Revenue [1979] AC 676
Australian and New Zealand Savings Bank Ltd v Federal Commissioner of Taxation (1992) 92 ATC 4630
Ashwick (Qld) No 127 Pty Ltd v Commissioner of Taxation [2008] FCA 853
AVCO Financial Services Ltd v Federal Commissioner of Taxation (1982) 150 CLR 510
Bailey v Federal Commissioner of Taxation (1977) 136 CLR 214
Bank of New South Wales v Brown (as official liquidator of Tom the Cheap (WA) Pty Ltd (in liq)) (1983) 151 CLR 514
BP Refinery (Westernport) Pty Ltd v Shire of Hastings (1977) 180 CLR 266
Briggs v James Hardie & Co Pty Ltd (1989) 16 NSWLR 549
Bristol and West Building Society v Mothew [1998] Ch 1
Brookton Co-operative Society Ltd v Federal Commissioner of Taxation (1981) 147 CLR 441
Cameron Brae Pty Ltd v Federal Commissioner of Taxation (2007) 161 FCR 468
Carapark Holdings Limited v Commissioner of Taxation (1967) 115 CLR 653
Charterbridge Corporation Ltd v Lloyds Bank Ltd [1970] Ch 62
Coles Myer Finance Ltd v Federal Commissioner of Taxation (1993) 176 CLR 640
Commissioner of Taxation v Bivona (1990) 21 FCR 562
Commissionerof Taxation v E A Marr and Sons (Sales) Ltd (1984) 2 FCR 326
Commissioner of Taxation v Jackson (1990) 27 FCR 1
Commissioner of Taxation v Stokes (1996) 72 FCR 160
Consolidated Press Holdings Ltd v Federal Commissioner of Taxation (1998) 88 FCR 151
Dakota Bank v Eiesland, 645 NW 2d 177 (Minn App, 2002)
Daly v Sydney Stock Exchange Ltd (1986) 160 CLR 371
Dan v Federal Commissioner of Taxation (No 2) (2000) 44 ATR 338
Dennis Willcox Pty Ltd v Federal Commissioner of Taxation (1988) 19 ATR 1122
Deputy Federal Commissioner of Taxation for New South Wales vBrown (1958) 100 CLR 32
Dinshaw v Commissioner of Income Tax (Bombay) (1934) 50 TLR 527
Equiticorp Finance Ltd (in liq) v Bank of New Zealand (1993) 32 NSWLR 50
Esanda v Burgess [1984] 2 NSWLR 139
Fairway Estates Pty Ltd v Federal Commissioner of Taxation (1970) 123 CLR 153
Farrow Finance Co Ltd (in liq) v Farrow Properties Pty Ltd (in liq) (1997) 26 ACSR 544
Federal Coke Co Pty Ltd v Federal Commissioner of Taxation (1977) 34 FLR 375
Federal Commissioner of Taxation v Australian New Zealand Savings Bank Ltd (1994) 181 CLR 466
Federal Commissioner of Taxation v Dalco (1990) 168 CLR 614
Federal Commissioner of Taxation v Firth (2002) 120 FCR 450
Federal Commissioner of Taxation v Linter Textiles Australia Ltd (in liq) (2005) 220 CLR 592
Federal Commissioner of Taxation v Macquarie Health Corporation Ltd (1998) 88 FCR 451
Federal Commissioner of Taxation v Marshall & Brougham Pty Ltd (1987) 17 FCR 541
Federal Commissioner of Taxation v Munro (1926) 38 CLR 153
Federal Commissioner of Taxation v Orica Ltd (1998) 194 CLR 500
Federal Commissioner of Taxation v R & D Holdings Pty Ltd (2007) 160 FCR 248
Federal Commissioner of Taxation v Sidney Williams (Holdings) Ltd (1957) 100 CLR 95
Federal Commissioner of Taxation v Total Holdings (Aust) Pty Ltd (1979) 79 ATC 4279
Federal Commissioner of Taxation v Unilever Australia Securities Limited (1995) 56 FCR 152
Ferguson v Commissioner of Taxation (1979) 26 ALR 307
Franklin’s Selfserve Pty Ltd v Federal Commissioner of Taxation (1970) 125 CLR 52
Freeman v Complex Computing Co Inc, 119 F 3d 1044 (2nd Cir, 1997)
Gate Gourmet Australia Pty Ltd (in liq) v Gate Gourmet Holding AG [2004] NSWSC 149
G E Crane Sales Pty Ltd v Federal Commissioner of Taxation (1971) 126 CLR 177
Giumelli v Giumelli (1999) 196 CLR 101
Guest v Federal Commissioner of Taxation (2007) 65 ATR 815
Hobart Bridge Co Ltd v Federal Commissioner of Taxation (1951) 82 CLR 372
Hooker Rex Pty Ltd v Federal Commissioner of Taxation (1988) 88 ATC 4392
Hope v Bathurst City Council (1980) 144 CLR 1
Inland Revenue Commissioners v Herdman [1969] 1 All ER 495
Kolotex Hosiery (Australia) Pty Ltd v Federal Commissioner of Taxation (1975) 132 CLR 535
Kordan Pty Ltd v Federal Commissioner of Taxation (2000) 46 ATR 191
Leo v Kerr-McGee, Civ A No 93-1107(JEI), 1996 WL 254054 (D NJ, 10 May 1996)
Levin & Co Ltd v Inland Revenue Commissioner (NZ) [1963] NZLR 801
Lighthouse Philatelics Pty Ltd v Commissioner of Taxation (1991) 32 FCR 148
Lonrho Plc v Fayed (No 2) [1992] 1 WLR 1
Magna Alloys & Research Pty Ltd v Federal Commissioner of Taxation (1980) 80 ATC 4582
MacCormickv Federal Commissioner of Taxation (1984) 158 CLR 622
Malouf v Federal Commissioner of Taxation (2008) 68 ATR 470
McAndrew v Federal Commissioner of Taxation (1956) 98 CLR 263
McLarty v R (2008) 293 DLR (4th) 659
Mathew v Blackmore (1857) 156 ER 1409
Mills v Mills (1938) 60 CLR 150
NEAT Domestic Trading Pty Ltd v AWB Ltd (2003) 216 CLR 277
Newtronics Pty Ltd (rec & mgrs appd) (in liq) v Atco Controls Pty Ltd [2008] VSC 566
Olsson v Dyson (1969) 120 CLR 365
NZI Capital Corporation Pty Ltd v Child (1991) 23 NSWLR 481
Point v Federal Commissioner of Taxation (1970) 119 CLR 453
Pioneer Concrete Services Ltd v Yelnah Pty Ltd (1986) 5 NSWLR 254
Pridecraft Pty Ltdv Federal Commissioner of Taxation (2004) 213 ALR 450
Puzey v Commissioner of Taxation (2003) 131 FCR 244
R v New Queensland Copper Co Ltd (1917) 23 CLR 495
Re United Railways of Havana and Regla Warehouses Ltd [1960] Ch 52
Saraswati v The Queen (1991) 172 CLR 1
Seltzer v IC Optics Ltd, 339 F Supp 2d 601 (D NJ, 2004)
Scarf v Jardine (1882) 7 App Cas 345
Spassked Pty Ltd v Commissioner of Taxation (2003) 136 FCR 441
Spedley Securities Ltd (in liq) v Greater Pacific Investments Pty Ltd (in liq) (1992) 30 NSWLR 185
Tomkinson v First Pennsylvania Banking and Trust Co [1961] AC 1007
Tweddle v Federal Commissioner of Taxation (1942) 180 CLR 1
United States v Bestfoods, 118 SCt 1876 (1998)
Walker v Wimborne (1976) 137 CLR 1
Walstern v Federal Commissioner of Taxation (2003) 138 FCR 1
Woolcombers (WA) v Commissioner of Taxation (1996) 66 FCR 66BHP BILLITON FINANCE LIMITED (ACN 008 519 319) v COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA
VID 788 of 2006
BHP BILLITON LIMITED (ACN 004 028 077) v COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA
VID 599 – 606 of 2008
GORDON J
30 MARCH 2009
MELBOURNE
IN THE FEDERAL COURT OF AUSTRALIA
VICTORIA DISTRICT REGISTRY
VID 788 of 2006
BETWEEN: BHP BILLITON FINANCE LIMITED (ACN 008 519 319)
ApplicantAND: COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA
Respondent
IN THE FEDERAL COURT OF AUSTRALIA VICTORIA DISTRICT REGISTRY VID 599-606 of 2008
BETWEEN: BHP BILLITON LIMITED (ACN 004 028 077)
ApplicantAND: COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA
Respondent
JUDGE:
GORDON J
DATE OF ORDER:
30 MARCH 2009
WHERE MADE:
MELBOURNE
THE COURT ORDERS THAT:
1.The parties confer and jointly file short minutes of proposed orders giving effect to these reasons by 4:00 pm on 3 April 2009. If the parties are unable to agree, they are to submit a joint statement by 4:00 pm on 3 April 2009 identifying: (1) the point(s) of agreement; (2) the point(s) of disagreement; and (3) the respective positions of the parties on the point(s) of disagreement, in which case I will list the matter for further directions or hearing as necessary. If further directions or hearing are sought, the parties should consult amongst themselves and then contact chambers with a list of mutually agreeable dates and estimated time required for the proposed directions or hearing.
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.
INDEX
Content
Par Nos
A
Introduction
[1] – [3]
B
Issues and Summary of Conclusions
[4] – [5]
C
Facts
[6]
(a) The BHPB Group
[7] – [8]
(b) Finance
[9] – [25]
(c) BHPDRI
[26] – [60]
(d) BHPTM
[61] – [87]
D
Bad Debt Claims
[88]
(a) Legislation
[89]
(b) s 25-35(1)(b)
[90]
(i) Finance in the business of lending money?
[91] – [104]
(ii) BHPDRI and BHPTM loans in ordinary course of Finance’s business of lending money?
[105] – [118]
(iii) BHPTM loan bad?
[119] – [134]
(iv) Conclusions on s 25-35(1)(b)
[135]
(c) Alternate arguments:
[136] – [137]
(i) s 8-1
[138] – [149]
(ii) s 25-35(1)(a)
[150] – [161]
E
Part IVA apply to disallow BHPTM bad debt deduction?
[162]
(a) Need an assessment to give effect to a determination under s 177F?
[163] – [184]
(b) Part IVA apply?
[185] – [194]
F
Division 243
(a) Introduction
[195] – [196]
(b) Legislation
[197] – [201]
(c) Facts
[202]
(d) Issues
[203] – [204]
(e) Analysis
[205] – [232]
(f) Conclusions about Div 243
[233]
G
Additional Tax
[234] – [235]
H
Conclusions and Orders
[236]
ABBREVIATIONS
“BHPB”
means BHP Billiton Limited, the applicant in VID 599-606 of 2008;
“BHPB Group”
means BHPB and the subsidiaries of which it is the ultimate parent company at any period of time;
“BHPB Proceedings”
means proceedings numbered VID 599-606 of 2008;
“BHPDRI”
means BHP Billiton Direct Reduced Iron Pty Ltd;
“BHPM”
means BHP Minerals, a segment of the BHPB Group;
“BHPM Holdings”
means BHPM Holdings Pty Ltd, the shareholder of BHPDRI;
“BHPIO”
means BHP Iron Ore, a segment of the BHPB Group;
“BHPTM”
known as Mineral Deposits Pty Ltd until 14 July 1995 when it changed its name to Titanium Minerals Pty Ltd;
“Commissioner”
means the respondent, the Commissioner of Taxation of the Commonwealth of Australia;
“Corporations Act”
means the Corporations Act 2001 (Cth);
“DCF”
means discounted cash flow;
“DRI”
means direct reduced iron, the metallic material formed by the removal of oxygen from iron oxide at temperatures below the melting point of iron. HBI (hot briquetted iron) is produced by the physical compaction or densification of DRI;
“Finance”
means BHP Billiton Finance Limited, the applicant in VID 788 of 2006;
“HBI”
means hot briquetted iron. See DRI;
“IRR”
means the internal rate of return;
“NPV”
means the net present value;
“the 1936 Act”
means the Income Tax Assessment Act1936 (Cth);
“the 1997 Act”
means the Income Tax Assessment Act 1997 (Cth);
“the 2000 year”
means the income year ended 30 June 2000;
“the TAA Act”
means the Taxation Administration Act 1953 (Cth).
IN THE FEDERAL COURT OF AUSTRALIA
VICTORIA DISTRICT REGISTRY
VID 788 of 2006
BETWEEN: BHP BILLITON FINANCE LIMITED (ACN 008 519 319)
ApplicantAND: COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA
Respondent
IN THE FEDERAL COURT OF AUSTRALIA VICTORIA DISTRICT REGISTRY VID 599-606 of 2008
BETWEEN: BHP BILLITON LIMITED (ACN 004 028 077)
ApplicantAND: COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA
Respondent
JUDGE:
GORDON J
DATE:
30 MARCH 2009
PLACE:
MELBOURNE
REASONS FOR JUDGMENT
A. INTRODUCTION
These proceedings concern BHPB and three of its subsidiaries – Finance, BHPDRI and BHPTM. Finance, the internal financier to the BHPB Group, financed projects approved by the board of directors of BHPB both initially and on an on-going basis, including projects constructed and operated by BHPDRI and BHPTM.
In the 2000 year, two projects partly financed by Finance – the HBI plant for which BHPDRI was responsible and the Beenup Project for which BHPTM was responsible – had not been successful. Finance wrote off as bad part of the debt owed by BHPDRI and part of the debt owed by BHPTM. The amounts written off by Finance in the 2000 year were:
1.$1,845,833,281.34, of a total debt of $2,191,833,281, due to it by BHPDRI. (There is a discrepancy of $0.34 which may be put to one side); and
2.$310,881,702.40, of a total debt of $339,216,146.22, due to it by BHPTM.
It is the writing off by Finance of these parts of the two debts (the BHPDRI loan and the BHPTM loan) in the 2000 year which is in issue in these proceedings. Two consequential steps for tax purposes were taken. First, Finance claimed as a deduction the amount written off pursuant to s 25-35 of the 1997 Act. Secondly, BHPB applied the debt forgiveness provisions to those write offs (Div 245 in Schedule 2C of the 1936 Act) but not the provisions concerning limited recourse debt in Div 243 of the 1997 Act.
B. ISSUES AND SUMMARY OF CONCLUSIONS
The writing off of part of each debt raises five issues:
1.whether Finance was entitled to an allowable deduction in respect of each amount written off as bad pursuant to s 25-35(1)(b) of the 1997 Act. The central question is whether Finance was in the business of lending money and, if so, whether each loan was made by Finance in the course of that business. In relation to the BHPTM loan, there is a further issue about whether the loan was bad;
2.alternatively to (1), whether Finance was entitled:
(a)pursuant to s 8-1 of the 1997 Act, to an allowable deduction in respect of each amount written off as bad;
(b)pursuant to s 25-35(1)(a) of the 1997 Act, to an allowable deduction of $424,204,013 in respect of the BHPDRI loan and $95,892,428 in respect of the BHPTM loan. These amounts related to interest which accrued under the loans and which had previously been included in Finance’s assessable income;
3.if yes to (1) or (2) in relation to that part of the BHPTM loan written off as bad, whether the Commissioner made a valid determination pursuant to Pt IVA of the 1936 Act to cancel that bad debt deduction claimed by Finance;
4.in the BHPB Proceedings, whether Div 243 and Pt 3-90 of the 1997 Act apply to disallow capital allowance deductions claimed by BHPB as head entity of a tax consolidated group in respect of assets of BHPDRI. The central question is whether the BHPDRI loan was limited recourse debt for the purposes of Div 243;
5.finally, if BHPB and Finance were unsuccessful in whole or in part in these proceedings, the question of the additional tax imposed by the Commissioner.
For the detailed reasons that follow, I consider that:
1.Finance was entitled to an allowable deduction in respect of each part of the debt written off as bad pursuant to s 25-35(1)(b) in the 2000 year. Finance was in the business of lending money and each loan was made by Finance in the course of that business. Moreover, contrary to the Commissioner’s submissions, the amount of the BHPTM loan written off was bad;
2.although these questions do not arise for consideration, nevertheless:
(a)pursuant to s 8-1 of the 1997 Act, Finance would have been entitled to an allowable deduction in respect of each amount written off as bad;
(b)s 25-35(1)(a) of the 1997 Act was not engaged. There was no interest written off as bad;
3.in relation to the BHPTM loan written off as bad, the Commissioner was entitled to rely upon s 169A(3) of the 1936 Act in making his s 177F(1)(b) determination. However, Pt IVA did not apply to otherwise disallow the allowable deduction in respect of the amount of the BHPTM loan written off as bad pursuant to s 25-35(1)(b);
4.in the BHPB Proceedings, Div 243 and Pt 3-90 of the 1997 Act did not apply to disallow capital allowance deductions claimed by BHPB as head entity of a tax consolidated group in respect of assets of BHPDRI. The BHPDRI loan was not limited recourse debt for the purposes of Div 243;
5.in light of my earlier findings, the question of additional tax does not arise. However, if I am wrong in any of the conclusions I have reached, I would have remitted a substantial part of the additional tax imposed by the Commissioner. The position adopted by BHPB and Finance was reasonably arguable.
C. FACTS
The facts relevant to the BHPB Group and the manner in which the group was managed are primarily sourced from the affidavits sworn by Mr Graeme McGregor, a former director of both BHPB and Finance and Mr Basil Ahyick, who was appointed in August 1994 as Finance’s “Supervisor Accounting”, appointed in January 1996 as “Financial Accountant [BHPB] Finance and Investments” and then appointed in January 1998 as “Team Leader SAP R/3 Project, [BHPB] Budgets and Accounting”. Their evidence in relation to these matters was not the subject of challenge.
(a) The BHPB Group
BHPB was incorporated in 1885 and is the ultimate parent company of a diversified group of multinational natural resource companies. In the 1990’s, the period with which these proceedings are primarily concerned, the BHPB Group’s principal areas of business were: the minerals group which undertook minerals exploration, production and processing principally of coal, copper, iron ore and manganese ore; the petroleum group which undertook hydrocarbon exploration, production and refining; and the steel group which undertook steel production and group corporate services.
The BHPB Group’s corporate services group provided transactional services to other members of the BHPB Group including in the areas of finance, treasury and accounting, human resources and supply and procurement. Finance, the applicant in VID 788 of 2006, formed part of the treasury section of the corporate services group.
(b) Finance
Finance was incorporated on 29 August 1975 as a wholly owned subsidiary of BHPB “for the purpose of borrowing funds to re-lend to Group companies”. Its Memorandum of Association records one of its objects is “to carry on the business of financier in all its branches both within and outside Australia”.
From September 1985, Finance was registered as a financial institution and a short term money market dealer / operator for the purposes of the Financial Institutions Duty Act 1982 (Vic) and s 98I of the Stamp Duties Act 1920 (NSW) [repealed by the State Revenue Legislation Amendment Act 2008 (NSW)]. By the early 1980’s, Finance had commenced raising finance from external lenders. From the early 1990’s, virtually all external borrowings of the BHPB Group to fund activities and projects of the BHPB Group were undertaken by Finance.
Centralisation of the financing activities of the BHPB Group within Finance provided, what were described as, numerous “administrative and corporate efficiencies” including ensuring that lenders and financiers dealt with one entity whose business could be readily understood by the finance community, centralisation of the foreign exchange operations of the BHPB Group for better monitoring and control of the group’s total foreign exchange exposure and hedging activities (with foreign exchange gains and losses being treated on revenue account) and enhanced transparency of the BHPB Group’s financial results by separating financing activities from operations.
As the principal financier, Finance raised money from financial institutions outside the BHPB Group by way of loan facilities, the issue of commercial paper and medium term notes. Each year, the BHPB board set the borrowing limits and the borrowing program to be carried out by Finance for the next 12 months. That program stipulated the proportions of short and long term debt, the mix of fixed and floating interest rate debt and the mix of currencies in which funds were to be borrowed. For example, for the financial year ended 31 May 1996, the BHPB board granted approval for loan and other financing facilities in the name of Finance (or any other wholly owned subsidiary) for an amount not exceeding $2,275 million. A committee of the board, consisting of two or more of the Managing Director, the Executive General Manager Finance and the Corporate Treasurer was appointed for the purposes of, inter alia, “[a]pproving, executing, delivering and performing all terms and conditions and documentation of loan and other financing facilities to be arranged by [Finance] or any other wholly owned subsidiary up to a total of $2,275 million and all terms and conditions and documentation of guarantees to be issued by [BHPB] in respect of these facilities”.
Consistent with the annual resolutions of the board of BHPB, over the relevant period Finance raised large sums of money from a variety of sources:
1.From banks and financiers outside of the BHPB Group by way of medium to long term facilities and by way of short to medium term facilities. In the period from 17 December 1986 to 8 May 1996, Finance was the borrower under medium to long term facilities totalling billions of dollars in various currencies from numerous international financial institutions including:
Agreement
DateLender
Amount Borrowed
17 Dec 1986
Industrial Bank of Japan Ltd; Fuji Bank Ltd; Long Term Credit Bank of Japan Ltd; Mitsubishi Bank Ltd; Sanwa Bank Ltd; Sumitomo Bank Ltd; Tokai Bank Ltd
USD66 million / JPY25.0789 billion
17 Dec 1986
Export – Import Bank of Japan
JPY25.0789 billion / USD66 million
16 Apr 1987
Dai-Ichi Mutual Life Insurance Co; Mitsui Bank Ltd (as Lenders); Mitsui Bank Ltd (as Agent)
JPY7.1 billion
14 Jan 1988
Sanwa Bank Ltd
USD100 million
29 Apr 1988
Mitsubishi Bank Ltd
USD100 million
31 May 1988
Long Term Credit Bank of Japan Ltd; Asahi Mutual Life Insurance Co
JPY6.25 billion
21 Jul 1988
Long Term Credit Bank of Japan Ltd; Nippon Life; Long Term Credit Bank of Japan Ltd (as Agent)
JPY6.62 billion
26 Jul 1988
Sumitomo Life Insurance Company
JPY5 billion
27 Jul 1988
Dai-Ichi Mutual Life Insurance Co; Industrial Bank of Japan Ltd; IBJ Australia Bank Ltd (as Arranger); Industrial Bank of Japan Ltd (as Agent)
JPY6.62 billion
27 Jul 1988
Dai Ichi Kangyo Bank Ltd
USD10 million
27 Jul 1988
Nissan Mutual Life Insurance Company
JPY5 billion
23 Sep 1988
Taiyo Mutual Life Insurance Co; Kyoei Life Insurance Co; Saitama Bank Ltd; Shizuoka Bank Ltd; Gunma Bank Ltd; Suruga Bank Ltd; Toho Bank Ltd; Bank of Osaka; Senshu Bank; Bank of Tokyo Ltd (as Arranger and Agent)
JPY10.1625 billion
15 Mar 1989
Export – Import Bank of Japan
USD175 million
9 Mar 1989
Nippon Dantai Life Insurance Co Ltd; Sumitomo Marine and Fire Insurance Co Ltd;
Tokio Marine and Fire Insurance Co Ltd;
Yasuda Fire and Marine Insurance Co Ltd; Daido Mutual Life Insurance Co; Nichido Fire & Marine Insurance Co Ltd; Bank of Tokyo (as Lead Manager and Agent)USD75 million
28 Apr 1989 Westpac Banking Corporation AUD100 million 26 Aug 1991 Kredietbank N.V. USD50 million 26 Nov 1992 Dai-Ichi Mutual Life Insurance Co; Sakura Bank Ltd (as Agent) JYP6.22 billion 18 Jan 1993 Sanwa Bank Ltd USD100 million 3 Jun 1994 Mitsui Trust Finance (Australia) Ltd USD100 million 19 Apr 1996 JP Morgan Australia Ltd USD250 million 8 May 1996 Banque Nationale de Paris and BNP Pacific (Australia) Ltd USD200 million
2.By the issue of promissory notes and commercial paper to raise short to medium term finance such as:
Date of Finance
Resolution
Facility approved
25 Oct 1985
US$700m note issuance facility
25 Oct 1985
US$300m (maximum total) Euro commercial paper program
29 Nov 1985
US$150m raising by issue of 10% US$ Eurobonds
23 Sep 1986
US$200m floating rate notes issue
21 Jan 1987
US$75m raising by issue of 14.25% guaranteed notes
27 Feb 1987
US$50m raising by issue of notes
19 May 1987
Unsecured promissory notes facility (increase of limit to A$300m)
19 Oct 1987
A$80m (total face value) 12.5% fixed rate notes issue
16 Feb 1988
A$100m bill facility
24 Feb 1988
A$400m bill endorsement/discount facility
24 Feb 1988
A$400m underwritten bill endorsement/discount facility
31 May 1988
A$55m (total face value) convertible bill facility (to US$ loan)
06 Jun 1988
A$150m Asian commercial paper program
23 Nov 1988
A$500m (total face value) fixed rate unsecured notes issue
22 Dec 1988
A$55m (total face value) convertible bill facility (to US$ loan)
23 Feb 1990
$A110m (total face value) convertible bill facility (to US$ loan)
27 Feb 1990
A$1b commercial paper facility involving issues of promissory notes
02 Aug 1991
Asian commercial paper program facility (A$150m increase to A$300m)
23 Feb 1993
A$1b commercial paper facility involving issue of promissory notes
25 May 1993
US$700m note issuance facility
13 Apr 1994
US$300m Euro commercial paper program (in conjunction with [BHPB] – Hamilton Oil Great Britain PLC)
20 Dec 1995
US$700m note issuance facility
26 May 1997
US$100m medium term floating rate notes issue
18 Nov 1997
A$1b commercial paper program
06 Oct 1998
US$450m standby note issue facility
06 Oct 1999
A$3b medium term note program
In addition, Finance entered into interest rate and currency exchange swaps with third party financial institutions to limit exposure to risks of fluctuations over the short and long term. Samples of some of the agreements entered into by, and information memoranda issued by, Finance were tendered in evidence. In respect of each loan agreement in evidence, Finance was the borrower with its obligations guaranteed by BHPB. It was also the issuer of the information memoranda (guaranteed by BHPB) and it was the contracting party to the Master Swap agreements (with the obligations guaranteed by BHPB).
During the 1990’s, Finance’s board comprised senior executives from the BHPB Group. By way of example, from 1996 to 1999, Mr GW McGregor, the Executive General Manager Finance for the BHPB Group, was also a director of both BHPB and Finance.
Finance did not have its own staff. It utilised the services of BHPB for which it paid management fees. The fees reflected the proportion of time BHPB personnel spent in providing services to Finance. In the case of Finance, most of the services provided by BHPB were accounting and treasury personnel.
The BHPB treasury personnel had responsibility for determining the cash flow requirements of the BHPB Group using data provided by the operating divisions and relevant corporate staff, arranging the funding of those requirements and determining the form in which the funds would be raised. Performance of those tasks was subject to “Treasury Guidelines” prepared annually by the Treasurer & Vice President Corporate Finance which were then reviewed by the Chief Financial Officer and ultimately approved by the BHPB board. The guidelines provided a series of rules and protocols for a wide range of matters including credit limits (the total amount that could be borrowed from third parties), foreign exchange risk management, guarantees, interest rate and currency swaps, loan facilities and money market activities.
The cash flow requirements of the BHPB Group were assessed on an annual basis through the preparation of annual rolling budgets. Each business unit prepared a budget. Those budgets were then aggregated to form the BHPB Group budget which was ultimately approved by the BHPB board. Preparation of the BHPB Group budget commenced in the March preceding the commencement of the next financial year. The budget forecasts (cash inflows and cash outflows) were prepared for five years on a rolling basis. The forecasts took into account “operating revenues, new (and yet to be approved) capital investments, capital expenditure sustaining existing projects, exploration expenditure and operating costs”. Once the budget was approved by the BHPB board, the budget necessarily identified the cash flow shortfall.
The manner in which the shortfall was funded was determined by the Corporate General Manager Taxation, the Corporate Treasurer and, ultimately, the Corporate General Manager Accounting. During the relevant period, the policy was recorded in Section 21.19 of the BHPB Accounting Policy Manual as at May 1996 entitled “Funding of Group Companies” in the following terms:
Details of proposed equity and / or debt funding of new group companies, or of revised funding structures for existing group companies, should initially be provided to the Corporate General Manager Accounting.
Proposals will be passed on to the Corporate General Manager Taxation and to the Corporate Treasurer for review.
The Corporate General Manager Accounting will provide Business Groups with a written “sign off” once the Corporate General Manager Taxation and the Corporate Treasurer have indicated that the proposed funding structure is acceptable. The proposed funding structure should only be put in place upon receipt of this “sign off”.
Continuous Review
Capital funding structures of controlled entities should be reviewed regularly to ensure that the structure remains appropriate to the entities’ operational and financial standing.
For example, the 100% debt funding of an existing company’s activities, other than on a temporary basis, is generally considered to be inappropriate. Similarly a company with high debt and little equity may need to have its structure reviewed if the consequential interest burden is leading the company into negative shareholder funds.
Reviews of company funding structures must be done in collaboration with the responsible taxation officer.
Before turning to consider the projects the subject of dispute in these proceedings, other aspects of the funding of group companies should be noted. First, most BHPB Group companies with bank accounts in Australian currency were part of an ANZ (AFT) sweep facility arranged through Finance. At the end of each day, each account balance was automatically transferred to a single bank account held by Finance. A similar arrangement was set up between Finance and Chase Manhattan Bank for BHPB Group companies with bank accounts maintained in US dollars. A positive bank account of a BHPB Group subsidiary swept to Finance resulted in a credit to the subsidiary’s loan account with Finance and each negative balance swept to Finance resulted in a debit to the subsidiary’s deposit account with Finance. Any surplus cash would then be placed by Finance on the overnight money market with third party financial institutions.
Secondly, as a result of the process of capital expenditure approval, selection of appropriate funding structures and the banking arrangements referred to in these reasons for decision, the value of loans made by Finance to BHPB Group companies totalled billions of dollars. For example, in the 1995 and 1996 years of income, Finance made loans to the entities listed in Schedule A totalling in excess of $17 billion. Finance had standard lending terms for the inter-company loans which, for the relevant period, were adopted by resolution of the board of Finance on 30 November 1994. Those terms provided:
… intercompany loans granted by [Finance] to [BHPB] or its subsidiaries (together the “[BHPB] Group”) from 1 December 1994 will, unless special terms are negotiated for a particular loan, be subject to the following conditions:
a)The interest rate will be 10.45% per annum or such other rate as may be nominated in advance from time to time by [Finance] as the relevant [BHPB] Group intercompany loan rate. Such interest shall be due and payable within 21 (twenty-one) days of the day on which the relevant outstanding loan is repaid.
b)Loans are to be made up of such amounts and are to be advanced on such dates as are agreed orally from time to time by the borrower and [Finance]. Each initial loan and each additional loan is to be for a period not exceeding five months at which time all loans shall become immediately repayable.
c)The currency of each loan will be Australian Dollars.
d)The application of the loan funds will be to fund normal operating activities including research and development where applicable, of the borrower.
e) Commitment fees will not apply.
f)Unless otherwise designated, any repayments shall be applied to reduce the earliest outstanding advance and then be applied first against individual loans in excess of $50,000.
g)For administrative convenience, each loan made by [Finance] under this arrangement will be entered into the one loan account. However it is acknowledged that each amount advanced is a separate loan.
h)[Finance] will consider renewing loans at the close of each five month period should the borrower advise (orally) that it wishes to do so.
One relevant change to these terms and conditions was an adjustment to the inter-company interest rate on 3 March 1995 as a result of a review undertaken by officers from the departments of Corporate General Manager Taxation and Manager Corporate Accounting. After that review, the Corporate Treasurer recommended the following rates apply:
Australian Dollars
11.40% on funds advanced by [Finance]
7.40% on funds borrowed by [Finance]Where interest payments/receipts are made/received sixty (60) days in advance, the following rates apply:
11.20% on funds advanced by [Finance]
7.20% on funds borrowed by [Finance]…
Would you please ensure that all subsidiaries are advised of these rates.
As a result of the standard loan terms and in particular cll (b) and (h) of those loan terms (see [21] above), each loan from Finance to a BHPB Group member (including BHPDRI and BHPTM the subject of dispute in these proceedings) was for a five (5) month term.
It is not in dispute that the interest rate charged on loans from Finance to BHPB Group companies was higher than the interest rate at which it borrowed those funds from external third parties and from other members of the BHPB Group. Interest derived by Finance on the loans made to BHPB Group members accrued on a daily basis and was returned as assessable income on an accruals basis in Finance’s income tax returns. As a result of the activities of Finance, it earned substantial interest income generating substantial accounting profits after tax and taxable income. The gross interest income, the accounting profits (after tax) and the taxable income of Finance from 1986 to 2002 (before rebates and deductions for tax losses carried forward by or transferred to Finance) was as follows:
Year Interest Income
$AUDAccounting
Profit After TaxTaxable
Income1986 1,409,469,373 90,229,086 114,154,910 1987 1,794,112,745 45,731,000 145,313,519 1988 1,260,286,254 536,068,290 76,965,039 1989 1,644,366,392 73,856,000 447,133,044 1990 2,123,000,365 453,106,000 148,808,478 1991 2,087,256,717 238,153,000 405,246,887 1992 1,513,908,695 44,180,632 169,544,782 1993 1,321,699,224 15,031,321 41,524,496 1994 1,005,508,556 231,322,166 (23,127,060) 1995 1,307,201,673 (276,567,336) 44,058,249 1996 2,131,370,433 480,571,938 531,718,141 1997 2,416,871,606 210,122,000 557,555,284 1998 2,171,794,804 (369,118,000) 422,385,267 1999 2,385,768,312 688,988,000 533,496,381 2000 2,935,745,157 (1,321,184,222) (1,659,815,608) 2001 3,305,477,562 80,730,978 776,410,060 2002 3,178,358,105 1,581,916,863 1,679,638,947 TOTAL $34,042,195,973 $2,803,137,716 $4,411,010,816
It is necessary to consider separately the projects constructed and operated by BHPDRI and BHPTM, the subject of dispute in these proceedings.
(c) BHPDRI
This project involved the construction of a HBI plant at Port Hedland in Western Australia to produce briquettes from iron ore fines which, in 1995, were not only considered to have little if any economic value but were an impediment to the extraction and sale of ore because of the area required to store the fines. The intention was that “the production and sale of HBI would convert fines with little value to a valuable product and would provide further economic value for the BHPB group” by: (1) enabling more lump ore to be extracted and sold; and (2) satisfying obligations imposed upon BHPM by the Western Australian Government to undertake secondary processing of iron ore in that State.
Advice and assistance was sought by BHPIO (TB Janes) about the capital structure of BHPDRI in June 1995. At that time, BHPDRI had paid up capital of $20 million and a submission to the BHPB board seeking approval for expenditure to build a HBI plant near BHPB’s Port Hedland operations had not yet been considered by the BHPB board. If the total expenditure for the project was ultimately approved, $300 million was forecast to be spent in the 1996 year. On the assumption that approval from the BHPB board was obtained, on 15 June 1995 BHPIO requested advice and assistance on the preferred capital structure and debt/equity mix and to put the necessary arrangements in place for the issue of additional equity, the establishment of an appropriate inter-company loan and to ensure that the internal funding procedures were correct.
On 16 June 1995, the Chief Executive Officer of BHPM (Mr JK Ellis) sought approval from the BHPB board for the expenditure of A$1,550 million to build the HBI plant near BHPIO’s Port Hedland operation. The HBI capital expenditure submission recorded that based on 100% BHPB ownership of the project’s assets (other than the tunnel), inter alia:
1.the nominal IRR of the proposal was 22.1% (17.7% real) with a payback period of 5 years from project completion in June 1998;
2.the incremental NPV was:
A$M
at 15% discount rate on real cashflows 160
at 12.5% discount rate on nominal cashflows 870
at 8.25% discount rate on real cashflows 9403.the forecasted results reflected the strategic and incremental benefits to the BHPB Group as a whole and, in particular, BHPB’s iron ore business, from the construction of the proposed HBI plant.
The BHPM Capital Procedures Manual in place in June 1995 dictated the structure and content of capital expenditure submissions including the HBI capital expenditure submission. For example, it was the Manual which required, inter alia, that:
1.submissions were authorised by the BHPB board on the basis of their BHPB Group impact and therefore had to be presented from that perspective. All inter-business group and inter-divisional group implications had to be considered including the strategic importance to BHPM, the relationship or impacts on the performance of other parts of BHPB and the rationale supporting the expenditure: Sections 2.2, 3.2, Appendix 1 – Submission Checklist.
2.all projects had to be in the first instance evaluated on an ungeared or unleveraged basis to highlight the basic return on total assets employed by the project: Appendix 4 – Common Pitfalls of Investment Analysis.
The board submission (see [28] above) was supported by a two volume feasibility report comprising (1) a detailed HBI Facility Financial Model and (2) BHPIO Consolidated and Entity Financial Summaries which had been prepared on two distinct bases. Summaries for ten entities were included, one of which was BHPDRI. Each entity summary considered the project on a stand alone basis for that respective entity on stated assumptions. For BHPDRI, on the assumptions stated, the summary assessed the HBI plant as having a nominal DCF rate of return of 3.5% over 20 years or with an NPV at 10% of negative $606 million. On 20 June 1995, consistent with Section 21.19 of the BHPB Accounting Policy Manual as at May 1996 entitled “Funding of Group Companies” (see [19] above), the Corporate Treasurer reviewed the HBI capital expenditure submission and expressed a number of concerns about the proposal to the Executive General Manager Finance.
On 28 June 1995, BHPM (Taxation) provided the advice sought by BHPIO in its memorandum of 15 June 1995 (see [27] above). The advice was in the following terms:
In response to your note of 15 June 1995, I feel it will be appropriate for BHPDRI to continue as the project entity.
Consideration should be given to funding with debt up to a level which is consistent with commercial debt funding levels for major industrial undertakings. You will recall that in the case of the Pilbara Energy project, a debt:equity ratio of approximately 3:1 was arrived at.
I envisage that [Finance] would lend to BHPDRI at the inter-company rate of interest.
…
There would be a very substantial pool of tax losses generated in this entity in initial years of development and operation from interest, R&D and capital depreciation. This will provide [BHPB] the desirable flexibility to utilise such tax losses under group tax relief arrangements to offset income and tax payments in other parts of the [BHPB] group. If [BHPB] invites future external participation in the project, arrangements should be structured to allow BHPDRI to remain a 100% [BHPB] entity so that project tax losses could continue to be transferred for the benefit of the Group. …
The next day, 29 June 1995, the board of BHPB approved capital expenditure of A$1,550m on the HBI project. The presentation to the BHPB board was made by the Chief Executive Officer of BHPM, Mr JK Ellis. Subsequent to the presentation and in response to questions raised during the presentation, on 5 July 1995 further details were provided by Mr Ellis to the Managing Director of BHPB about the profit impact of additional ore sales and the composition of the consequential capital of $1,200m included in the HBI cash flow analysis.
What then occurred was not explained other than in the most general terms. However, the loan facility for BHPDRI was established with Finance. It was not in dispute that the terms of that loan were in accordance with Finance’s standard lending terms for inter-company loans which were adopted by resolution of the board of Finance on 30 November 1994 set out at [21] above.
As a result of the standard loan terms and in particular cll (b) and (h) of those terms (see [21] - [23] above), each loan was for a five (5) month term. To accommodate the fact that at the end of each five month period a fresh advance was made, there were two loan accounts for the loan to BHPDRI from Finance – account numbers 325320 and 326320 – which were used for alternate 5 month periods. Initially loan account 326320 was used. The opening entry in that account on 31 July 1995 was a debit entry of $8,200,137.58 with the notation “I/CO TRANSFER REF G KERNI”. On 1 October 1995, that loan account with a debit balance of $20,422,717.50 was closed and a new advance in the sum of $20,422,717.50 was made by Finance to BHPDRI in account number 325320.
In October 1995 and May 1996, the directors of BHPDRI resolved to allot 35 million and then, subsequently, 75 million $1.00 shares to BHPM Holdings.
During September and October 1996, an exhaustive review of the HBI project was undertaken. As a result of that review, two events occurred in November 1996. First, on 12 November 1996, BHPIO (T Janes) revisited the question of the capital structure of BHPDRI which had been adopted in June 1995 (see [31] above) and secondly, BHPM sought approval from BHPB for additional capital expenditure of A$140 million over and above that approved in June 1995. That capital expenditure submission was prepared in accordance with the Applicable Capital Procedures Manual then in place dated October 1996.
Prior to the further capital expenditure submission being considered by the BHPB board, both the question of the appropriate debt/equity mix and funding structure for the capital expenditure, consistent with the BHPB Accounting Policy Manual (see [19] above), was considered by Corporate Taxation. Approval was received for:
1.an equity investment of $370m to be made by BHPM Holdings in BHPDRI after 31 December 1996; and
2.to continue the equity funding of BHPDRI on the basis of a 50 / 50 debt to equity ratio (as had existed).
In reaching those conclusions, the required debt to equity level was considered. The advice provided by BHPM Taxation on that issue was that:
… it has been seen that the selection of a debt to equity ratio is a matter of choice. The selection should therefore take into account the intended purpose of the company. This company will primarily be involved in the export sale of beneficiated product where it maybe [sic] competing directly with local suppliers in foreign countries. From past experience with claims that our companies are resorting to unfair competition by dumping produce on foreign markets based on the observation that the particular companies never make any profits we need to ensure that this company is not saddled with a level of debt that leads to it being branded in the same way. For this reason we consider that the current debt to equity ratio (50%/50%) should be maintained.
On 29 November 1996, the BHPB board approved revised capital expenditure on the HBI project from A$1,550,000,000 to $1,673,600,000. The approved increase was $123.6m. Consistent with the advice received from Corporate Taxation, on 30 January 1997 the directors of BHPDRI resolved to allot 370 million $1 shares to BHPM Holdings.
As the general ledger for the loans from Finance to BHPDRI records, Finance advanced funds to BHPDRI which, together with the subscriptions of capital, were used progressively to pay expenses incurred by BHPDRI in the development and construction of the HBI plant. In addition, the general ledger trial balance recording the loan from Finance to BHPDRI reflects that the loan was conducted in accordance with Finance’s standard lending terms for inter-company loans adopted by resolution of the board of Finance on 30 November 1994 (see [21] - [23] above).
In August 1997, BHPB’s Managing Director (Mr Prescott) asked Mr McGregor to conduct a review of the HBI project. At that time, one of the central issues raised by Mr Prescott was that, from the start of the project, not all of the risks associated with the project were understood. At the time of the review, Mr McGregor was Executive General Manager Finance for the BHPB Group as well as a director of both BHPB and Finance. The review was completed by 11 September 1997 (“the HBI Audit Report”). The HBI Audit Report attached to the memorandum from Mr McGregor is important. That report stated, inter alia, that:
1.the projected NOPAT [net operating profit after tax] and ROC [return on capital] from the HBI plant per se were very modest, which was recognised at the time of the initial capital submission;
2.escalation in Capex and cash operation costs (thought to be $140 per tonne) meant that the HBI project on a stand alone basis would not generate a return in excess of 1.5% to 2.5%. (This is to be compared with the fact that the Detailed Capital Submission Report in 1995 showed that the HBI Plant on a stand alone basis had a DCF rate of return of 3.5%);
3.HBI was a low margin business that needed cheap gas, cheap electricity, low capital costs and low operating cost to succeed and the HBI project was challenged in relation to each of these matters.
At that time, the choice was to abandon the project altogether or persist with completion as economically and expeditiously as possible. In the best interests of Finance and the BHPB Group, Mr McGregor concluded that “a forward view of the project reveal[ed] that there [was] no case to be made for either abandoning the project or slowing it down [and that] the only sensible course of action [was] to complete the project as expeditiously and cheaply as possible”. As a result, Mr McGregor sought approval for total capital expenditure on the HBI plant of $2,275 million plus $128 million for commissioning costs. Consistent with the McGregor recommendation, on 18 November 1997, the Chief Executive Officer of BHP Ferrous Minerals forwarded to the Managing Director of BHPB (Mr Prescott) a memorandum entitled “[HBI] Project Supplementary Authorisation” seeking additional capital expenditure of $730 million, an increase of 44% above the existing authorisation. Based on an incremental cost to complete the project of $550 million, the memorandum reported that (1) the incremental NPV (nominal at 12.5%) was expected to be $888 million with a nominal IRR of 32.3% and (2) if the project did not proceed, the associated NPV loss was expected to be $429 million. The projected cash flows from the HBI project were set out in Attachment 1 to the “[HBI] Project Supplementary Authorisation” to be:
Financial Summary
Year 1 1998
Year 2 1999
Year 3 2000
Year 4 2001
Year 5 2002
Subsequent Years (Average)
Cash Flow A$M
-948.8
-549.8
-91.8
360.5
244.7
557.1
The uncontroverted evidence was that these projected “cash flows” were calculated prior to commissioning of the project by reference to the outgoings incurred, and then, after commissioning, were calculated by deducting expected costs and the cost of replacement of capital from projected revenues. By year six, the projected cash flows were positive. A payback period of six to seven years was expected.
Mr McGregor’s recommendation together with the supplementary capital expenditure submission was considered and accepted by the BHPB board on 27 November 1997. After the board meeting, the Managing Director of BHPB (Mr Prescott) forwarded a memorandum to the Chief Executive Officer BHP Ferrous Minerals, copied to the Executive Director Finance, on 1 December 1997 in the following terms:
I confirm that the Board at its meeting on 27 November gave approval for completing and commissioning the Pilbara HBI project as recommended in your memo of 18 November 1997. In so doing the Board gave approval for the expenditure of an additional $730 million on the project comprising $668 million in additional capital spending and $62 million in additional capitalised pre-commissioning operating expenditure.
In implementing this approval the following imperatives apply:
1. Every effort must be made to improve the commercial outcomes of the entire project.
2. There is to be clear and thorough reporting of all significant developments in a timely fashion including all management action to address issues that may arise or opportunities for project outcomes to be improved.
3. This reporting is to be monthly through Iron Ore’s Business Reports and through appropriate comments in the Managing Director’s Report, also monthly through Project Management’s Business Report and quarterly (or more frequently if required) in the Business Reports presented to the Board.
4. We are to pursue the proposal to sell down 15% of the project to our Japanese partners in our other iron ore businesses.
5. We are to further investigate the advantages and disadvantages of iron ore feed price alternatives to the plant.
A copy of this memorandum was sent to Mr Lance Coburn who at this time was the Group General Manager, BHPM Finance. In his capacity as Group General Manager, BHPM Finance, Mr Coburn had responsibility for the financial aspects of BHPM, which included preparation of statutory accounts for most of the entities within BHPM, and responsibility to ensure compliance with BHPB Group policies and procedures in preparation of capital expenditure submissions and compliance with capital expenditure approvals.
On 5 December 1997, the Group General Manager BHPB Budgets and Accounting sent a note to Mr McGregor (at that time the Executive General Manager, Finance and a director of Finance) entitled “Asset Carrying Values”. The note listed those assets which did not or would not provide a return of 10% or greater by May 1998 based on current book values. One of the assets listed was the HBI plant as a stand alone asset. The NPV of that operation based on book value determined on a 10% DCF basis was negative $657 million. This value did not include any benefits from the plant to be derived by the iron ore mines.
Construction of the HBI Plant continued throughout 1998. Two critical events occurred during the course of that year. At the end of the 1998 financial year (31 May 1998) the board of BHPB changed its accounting policy for determining the recoverable value of non-current assets from undiscounted future net cash flows to discounted cash flows using the weighted average pre-tax interest rate of the BHPB Group’s long term borrowings. This change was adopted to reconcile the accounts prepared under the Australian generally accepted accounting principles (“GAAP”) with those applicable under United States GAAP. As a result of this change, adjustments were made to the recoverable value of non-current assets which resulted in changes to BHPB’s profit and shareholders’ equity. In the case of BHPDRI, as at 31 May 1998, the carrying value of BHPDRI’s non current assets was written down by $590 million. The financial effect of the write down was to reduce the carrying value of certain assets of BHPDRI by that amount and to reduce BHPDRI’s profit by $377,600,000 (after tax).
The second event was an update on the HBI project presented to the BHPB board on 27 November 1998. By that time, construction of the plant was “largely complete” with the first briquette expected at the end of January 1999. However, there were still problems. The US scrap price had plunged to new depths and the estimated sales of briquettes would not require full plant capacity once the plant was completed and commissioned. At that time, the options were to “[c]ommission all trains on current schedule (1/99, 4/99, 5/99, 6/99) [and] Operate 1 train and others necessary to meet market” or “Defer Completion & Commissioning Module 2 [and] Commission & Operate When Market Justifies (2002?)”. On 30 November 1998, the BHPB board agreed that BHP Ferrous Minerals “should complete construction of the entire plant, commission all trains on [the] current schedule and then operate only those trains necessary to meet (R&D) testing and product sales requirements”.
Consistent with the recommendation and subsequent approval by the BHPB board, train 1 of the HBI Plant was commissioned in early January 1999. However, it was shut down after 10 days because of production difficulties associated with the reduction process to produce DRI. The production difficulties were caused by the iron ore and partly reduced material not flowing continuously through the reactor train. There were frequent, sudden flow stoppages which upset the process and any attempt to balance the heat and mass flows in the reactor. In addition, the stoppages greatly increased the rate of accretion growth which required the reactors to be cleaned every 25 rather than every 160 days. At the end of the 1999 financial year, the carrying value of the HBI plant was written down by a further $531 million after tax.
On 21 July 1999, a letter was sent on BHPB letterhead from Joe Czyzewski, a director of Finance, to the directors of BHPDRI in the following terms:
[Finance] is aware that [BHPDRI] has commenced selling product and is working towards generating a viable cash flow in order to service its loans.
In the circumstances, [Finance] confirms that it does not intend for the period of twelve month’s (sic) from the date of this letter, or for such shorter period as we may specify at our election, intend to seek repayment of any loan it may have with [BHPDRI] but shall keep the company’s commercial performance under ongoing review.
Prior notice shall be given to you should it become necessary for [Finance] to take action in respect of any loan.
In March 2000, a further review of the HBI project was undertaken in response to the BHPB board’s concerns about current performance of the operations and the inability of the plant to meet commissioning targets. At the BHPB board meeting on 23 March 2000, a presentation was made about the future of the HBI plant. The board resolved: (1) that trials to assess the technical adequacy and commercial viability of the HBI facility should proceed until September 2000 when the board would again review the investment; and (2) to approve additional capital expenditure of $46 million. At the same time, a review of the carrying value of the asset was to be completed by the end of April 2000.
The board of Finance met on 30 March 2000. After noting the decisions of the BHPB board on 23 March 2000 and that BHPDRI was indebted to Finance in the amount of $2,113,944,530, the Finance board resolved to write to the BHPDRI directors to advise them that Finance would conduct a review of the loan by engaging Ernst & Young as independent experts to report on the valuation of the loan. Pending receipt of the Ernst & Young report, the directors of Finance agreed that a provision be made against the loan in Finance’s books by adopting the “worst case” scenario which indicated a negative carrying value of the loan. Further consideration of the question of interest on the loan was deferred pending receipt of the Ernst & Young report. Moreover, the directors of Finance agreed to review the provision of further loans to BHPDRI after discussions with BHPB management and to keep the BHPDRI loan under close review. On 3 April 2000, Finance informed BHPDRI of these matters.
As a result of Finance making provision on 31 March 2000 of a $2,174 million doubtful debt for its loan to BHPDRI, Finance was left with negative net assets in excess of $940 million. The BHBP Group Treasurer (Mr Czyzewski) was concerned that if the situation was not corrected, Finance may have been in breach of its various loan and financing arrangements. Accordingly, on 7 April 2000, he sought immediate approval for BHPB to seek an allotment of 950 million ordinary fully paid up shares in Finance (the consideration for such an allotment was to be $950 million).
On the same day that approval was sought for BHPB to seek allotment of 950 million shares in Finance (7 April 2000), the Chief Financial Officer of BHPB wrote to BHPDRI in the following terms:
At its meeting on 23 and 24 March 2000 the Board of [BHPB] approved additional funding of [BHPDRI] until September 2000. [Finance] has discussed the provision of further loan funds to [BHPDRI] through the existing intercompany loan facility and advised that it is unable to fund the further approved expenditure.
The shareholder of [BHPDRI], [BHPM Holdings] has agreed to inject equity into [BHPDRI] with a total issue price of $150 million. This equity injection will be completed immediately. [BHPB] has agreed to subscribe for equity in [BHPM Holdings] as may be necessary to enable [BHPM Holdings] to meet the equity injection into [BHPDRI].
Approval for BHPB to seek an allotment of 950 million shares in Finance was provided and, on 11 April 2000, the directors of Finance resolved to allot 950 million ordinary fully paid $1.00 shares to BHPB.
At the same time, BHPB Accounting and Reporting made changes to the loan account between Finance and BHPDRI on 10 April in the following ways:
The current loan account between [Finance] and [BHPDRI] (account number 23700011) will be ‘frozen’ at the 31 March 2000 closing balance, including capitalised interest yet to be booked to that date (Note: there have been no transactions since 1 April 2000).
To facilitate the day to day cash transactions of [BHPDRI], an intercompany loan account between [BHPB] and [BHPDRI] has been established and should be used from today. The account number is 23700012 and is a standard [BHPB] short term, interest free loan.
Following the $150 million equity injection, this intercompany loan account must be maintained as an asset loan (debit balance) in [BHPDRI’s] accounts as the funding of HBI operations is via equity not the loan facility. A request for further equity funding will be necessary if required. …
(emphasis in original).
After providing their preliminary views in April 2000, Ernst & Young tendered their report on the valuation of the BHPDRI loan receivable to the directors of Finance on 3 May 2000. Ernst & Young concluded that the value of the HBI plant did not exceed $346 million and had a nil value if the plant was closed. The report was considered by the directors of Finance at a meeting of the board held on the day the report was issued, 3 May 2000. The directors resolved that:
1)the Directors having made due inquiries and on the basis of the advice and conclusions given to Directors by the independent expert, have formed the view that the amount of $1,845,833,281 lent to [BHPDRI] is irrecoverable and bad and be written-off as bad;
2) (a)the entries be made in the accounts of [Finance] to record the write-off of the irrecoverable amount pursuant to Resolution 1 forthwith; and
(b)the provision continue to be carried against the balance of the loan not written-off being $346,000,000.00.
3)subject to the above accounting entries being completed, [BHPDRI] be subsequently notified that due to the poor financial condition of [BHPDRI] it would not be economically prudent to expend additional monies in taking proceedings to recover any or all of the said monies once they have been written off …
The Directors went on to note that interest on the loan would continue to be capitalised on the balance not written off and provided as doubtful.
On 10 May 2000, Finance wrote to both the directors of BHPDRI and to BHPDRI advising of the loan write off of $1,845,833,281 against the outstanding principal and interest of $2,191,833,281 and that following the write off, the directors of Finance had resolved not to take any further action to recover the debt written off as it appeared practically irrecoverable but that Finance reserved the right to recover the balance. The letter went on to state that Finance did not intend to seek repayment of the balance for the period up to 15 June 2001.
On 18 May 2000, the directors of BHPDRI resolved to allot 150 million $1 shares to BHPM Holdings. On 31 May 2000, BHPDRI wrote off the balance of its HBI investment in the sum of $794 million after tax. Towards the middle of 2000, things appeared to improve after significant further capital expenditure expended to alter the process conditions within the reactor essentially resolved the initial problems.
At 30 June 2000, BHPB applied Div 245 of Schedule 2C of the 1936 Act to cancel the losses and Finance claimed the bad debt deductions under s 25-35(1)(b) of the 1997 Act.
On 24 May 2001, the BHPDRI directors resolved to allot an additional 45 million $1 shares to BHPM Holdings.
Over 2003 and 2004, levels of production at the HBI plant increased. However, the HBI plant continued to be plagued by upsets in production. By May 2004, operations had been suspended following an accident which resulted in the death of one employee and serious injury to three others. After a detailed review of options for the plant, BHPB announced on 24 August 2005 that it would permanently close the HBI Plant.
(d) BHPTM
BHPTM (known as Mineral Deposits Pty Ltd until 14 July 1995) had a long history of mining titanium minerals. It had titanium minerals mining operations and a processing plant in New South Wales. BHPTM also held a mining lease over a large resource of titanium minerals (predominantly ilmenite) at Beenup in Western Australia.
In November 1994, the proposal was to develop ilmenite mining and processing facilities at Beenup in Western Australia and to purchase an interest in an existing ilmenite smelting facility at Tyssedal in Norway. The proposal was to mine the ore body (containing ilmenite and other heavy minerals) at Beenup and to truck the heavy mineral products to the Port of Bunbury for export to the Tyssedal Facility and other users. The mine and associated processing facilities were to be conducted by BHPTM.
On 15 November 1994, the Chief Executive Officer of BHPM (Mr JK Ellis) sought approval, by way of submission, from the BHPB board for the expenditure of A$222.6 million for the purpose of developing the mining and processing facilities at Beenup in Western Australia and the purchase of an interest in the existing Tinfos ilmenite smelting facility at Tyssedal in Norway. The capital expenditure submission recorded, inter alia, the nominal IRR of the proposal was 19.1% (15.2% real) with a payback period of 6.7 years.
On 21 November 1994, the Corporate Treasurer (Mr Zimmerman) sent a memorandum to the Executive General Manager Finance analysing the BHPM capital expenditure proposal. At that time, the “major technical risks” were that there was “no mineral sands experience of dredging to 45 metres depth and that the deposit [had] a high slimes content”. The BHPB board approved capital expenditure of $222,600,000 for the BHPTM project at Beenup on 24 November 1994.
The general ledger trial balance recording the loan from Finance to BHPTM reflects that the loan was conducted in accordance with Finance’s standard lending terms for inter-company loans adopted by resolution of the board of Finance on 30 November 1994 (see [21] - [23] above). As a result of those loan terms and in particular cll (b) and (h) of the standard loan terms, each loan was for a five (5) month term.
On 5 July 1995, a two year letter of comfort was provided by BHPB to the directors of BHPTM. So far as is relevant, the letter stated:
1. Existing Debts
[BHPB] undertakes to your company to ensure that your company is provided with sufficient funds to pay those debts which your company has elected to incur before the date of this undertaking, if your company is called upon to pay those debts and if, but for this letter, your company would now be insolvent.
2. Future Debts
[BHPB] undertakes to your company to ensure that your company is provided with sufficient funds to pay debts which your company elects to incur after the date of this undertaking, if your company is called upon to pay those debts, and if, but for this letter, your company would be insolvent at the time when it incurs the debt or as a consequence of incurring the debt.
3. Meaning of “Debts”
Notwithstanding anything in Clause 1, 2 or 5, this letter applies only to debts which your company incurs or has incurred:
(a)in the normal course of its operations;
(b)in accordance with all relevant approved operating and capital budgets, business plans, policies and procedures of [BHPB] or otherwise with the express or implied approval of [BHPB].
4. Discharge by Payment or Subscription
Without limiting any other right of [BHPB], [BHPB] may completely discharge its obligations under this letter in respect of any debt by subscribing for shares issued by your company with a nominal value equal to the amount of the debt or by paying the amount of the debt to your company at any time.
5. Termination
5.1 Upon the earlier of:
(a)the expiry of two (2) years from the date of this letter; or
(b)your company receiving from [BHPB] a notice which states that this letter is revoked,
this letter shall forthwith cease to be of effect, except in respect of debts which exist before that time.
…
6. Benefit of letter: Reliance
This letter is for your benefit of your company and its directors only, and is not to be relied upon by any other person.
The loan funds provided by Finance were used to fund the continuing development of the Beenup mine from 1995. Production at the mine commenced on 13 January 1997. At that time, BHPTM already had entered into a long term contract to supply ilmenite to a BHPB joint venture in Norway (“the Norwegian Contract”).
On 17 July 1997, a second letter of comfort was provided by BHPB to the directors of BHPTM. Again, so far as is relevant, the letter was largely in the same terms as the first letter of comfort (see [66] above) but for cl 5.1(a) which stated “the expiry of one year from the date of this letter”. The board minutes of BHPTM resolved that “on the basis of” the 17 July 1997 letter of comfort, there were reasonable grounds to believe that BHPTM would be able to pay its debts as and when they fell due and the board authorised the directors to sign the relevant statement to be provided under s 301 of the Corporations Law.
By late 1997, BHPTM’s Beenup mine had experienced significant operational difficulties. The material being mined at Beenup was much harder than expected. Further complications had arisen in disposing of and storing the tailings from the mining operations.
By the end of the 1998 financial year (31 May 1998), the project was continuing to encounter serious difficulties and, as a result, was not meeting its contractual commitments to supply titanium minerals to customers. Two steps were taken by BHPTM. First, BHPTM declared force majeure under the terms of the Norwegian Contract and secondly, following a review of the carrying value of assets undertaken as part of the preparation of BHPTM’s financial statements for the 1998 year (ending 31 May 1998), on 18 June 1998 Mr McGregor (as Executive General Manager Finance) recommended to the BHPB board that it approve writing down the carrying value of the Beenup assets by $99 million (after tax) on the assumption that an economically feasible solution would be developed to overcome the operational difficulties at the mine. As noted earlier (see [45] above), on 31 May 1998, the BHPB Group changed its accounting policy for determining the carrying value of assets.
On 9 July 1998, a third letter of comfort was provided by BHPB to the directors of BHPTM. But for the date, the letter was in the same terms as the second letter of comfort (see [68] above). The board minutes of BHPTM again resolved “on the basis of” the 9 July 1998 letter of comfort that there were reasonable grounds to believe that BHPTM would be able to pay its debts as and when they fell due and the board authorised the directors to sign the relevant statement to be provided under s 301 of the Corporations Law.
Between May and November 1998, further work continued on the Beenup mine particularly in relation to the issue of disposal of the tailings. Throughout this period, the board of BHPB continued to approve and support the operations. In December 1998, a parallel process examining “exit possibilities” commenced.
The carrying value of the Beenup assets was again reconsidered during the preparation of the half yearly accounts for the period ended 30 November 1998. Following consideration of a memorandum prepared by Mr Jim Hall (the Group General Manager BHPB Budgets & Accounting) to the Executive Director Finance dated 3 December 1998, the audit committee of BHPB resolved at a meeting on 17 December 1998 that the carrying value of the Beenup assets be retained at $114 million. The memorandum recorded:
1.at 31 May 1998, the carrying value of the Beenup assets was written down by $150 million (pre tax) to $134 million because of technical and other operational problems;
2.between 31 May and 30 November 1998, significant progress had been made on a tailings disposal solution but the work was approximately 4 months behind plan;
3.the carrying value for the half year November 1998 was fundamentally unchanged from May 1998 and again assumed an economically feasible technical solution to the technical and other operational problems;
4.at the BHPB board meeting on 27 November 1998, a quarterly review of the Beenup project was presented to the board at which time the board agreed to continue with operations and in parallel to examine exit options, including by sale, merger or closure;
5.the exit options and valuations were to be formalised by 31 May 1999 and if the closure option was adopted, then in addition to considering the carrying value, the BHPB accounts would need to include allowance for rehabilitation and site closure costs, breach of contract claims from customers and other costs.
Technical difficulties, however, continued to affect the mine and, in February 1999, a decision was made to close the plant and write off the balance of the carrying value of the investment. On 26 February 1999, BHPB issued a press release announcing the closure of the mine in the following terms:
The decision follows an extensive study into technical problems caused by the high clay content of the Beenup orebody which had impacted on the management of tailings and the mine’s ability to reach satisfactory levels of production.
President [BHPTM], Mr CE (Colin) Smith said the Company had directed considerable engineering and technical resources at resolving the problems at Beenup over a 12 month period. “After significant effort, it just wasn’t possible to find a feasible solution that would allow the operations to continue. … there comes a time when a company has to made hard decisions on a project such as this. That time has come. We have taken the engineering and technical research as far as we can.
Mr Smith said [BHPB] had looked for a buyer with access to different technology and alternative business objectives for Beenup, but it had become apparent in recent days that this would not be possible. The search included major titanium mineral producers and processors around the world.
[BHPB] is committed to continuing to manage and effectively address all environmental issues at the site. A detailed decommissioning and minesite rehabilitation plan is being prepared …
Costs of the write-off of the current book value of the Beenup assets, site rehabilitation and mine closure are expected to be approximately $150 million after tax.
(emphasis added)
Operations at the plant ceased on 16 April 1999. After the mine closed, the directors of BHPTM conducted a review of options available to the company and considered the means by which BHPTM might have been able to service its loan with Finance. That review continued at least from May until August 1999.
On 31 May 1999, Finance provided approximately $62 million to BHPTM to enable it to repay an overdraft it had with the ANZ bank.
On 8 July 1999, a fourth letter of comfort was provided by BHPB to the directors of BHPTM. Again, so far as is relevant, the letter was largely in the same terms as the second letter of comfort (see [68] above) but for the addition of the words “[i]t does not and is not intended to impose any contractual or legal obligations on [BHPB] in respect of any other person nor bind it to any particular requirement or course of action” to the end of the letter. Before that letter of comfort was considered by the directors of BHPTM, the Group Treasurer (Mr J Czyzewski) informed the directors of BHPTM by letter dated 9 July 1999 that:
I note that the Directors are expecting to have the benefit of a Letter of Comfort from its parent, [BHPB], in the same form as the attached draft.
[Finance] confirms that it will not demand payment of its loan to the company pending a complete review of the company’s future operations, including current proposals to transfer a commercial Group operation into the company.
[Finance] shall review its position in six months time or earlier as warranted in the circumstances.
[Finance] shall advise the directors prior to taking any action in respect of its loan following the review.
At a meeting held on 19 July 1999, the directors of BHPTM tabled the annual accounts for the 1999 year and after referring to the 8 July 1999 letter of comfort undertaking “(on a conditional basis) to provide sufficient funds to the Company to enable it to pay debts which the Company elects to incur”, the board was of the opinion “there were reasonable grounds to believe that [BHPTM] would be able to pay its debts as and when they fell due” and authorised the directors to sign the relevant statements to be provided under the Corporations Law.
BHPTM completed its review of options by early August 1999. At a meeting of directors of BHPTM on 18 August 1999 (chaired by Mr Coburn) the directors considered the options for meeting the existing and ongoing obligations of BHPTM. The minutes record what transpired at that meeting in the following terms:
The outcome of recent discussions with the owners of certain profitable mining operations regarding proposals for the transfer of assets into [BHPTM] to strengthen its balance sheet, and as a result, to assist with the servicing of the [Finance] debt, was discussed. It was noted that the discussions under consideration had produced no agreement and will not be pursued.
It was agreed that no other options for improving the liquidity of [BHPTM] were apparent and it was therefore necessary to consider the means of meeting the company’s existing and future obligations, in particular, the loan payable to [Finance].
[Finance] had provided an undertaking not to call its loan until a review of the reorganisation opportunities had occurred. [Finance] has now requested the company to provide details of this review on Friday 20 August 1999. It was agreed that Mr Coburn make the presentation to the board of [Finance].
Finally, the directors examined the balance sheet of the company to ascertain the likely shortfall on realisation of the company’s assets to meet existing obligations in the event that a demand for payment may issue from [Finance]. The directors are currently relying upon the terms of the comfort letter that was provided by the parent, [BHPB], on 8 July 1999. …
On 20 August 1999, two events occurred. First, BHPTM (Mr Coburn) sent a letter to Finance concerning the future operations of BHPTM. The letter stated:
BHPTM has been closely reviewing certain options for the transfer of a profitable mining operation into the company to bolster its balance sheet, and as a corollary, to introduce some means of servicing its loan from [Finance] over an extended period, thus avoiding an event of default.
The discussions with other Group entities concerning these proposals have ended without agreement as the options under consideration were not feasible. In view of this, the prospects of expanding the company’s activities to assist with the servicing and repayment of its debt to [Finance] are now, in all likelihood, non-existent.
The directors are presently reviewing the company’s balance sheet to assess its ability to meet existing and ongoing obligations. Should [Finance] call [on] its loan in the immediate future, the directors believe that [Finance] would realise little more than the amount of $11.5 million that BHPTM currently has on deposit with [Finance].
That letter, together with a presentation on the financial position of BHPTM from Mr Coburn, was considered at a meeting of directors of Finance held on 20 August 1999. By that date, Mr McGregor had taken leave of absence pending his imminent retirement and the directors attending the meeting were Mr Czyzewski (the Corporate Treasurer) and Messrs HE Rose and BJ Skahill. BHPTM’s financial position was summarised as follows:
1.YEM ’99 financials poor
· Nopat [Net Operating Profit After Tax] Loss $13 million [before abnormals]
· Ebit [Earnings Before Interest and Tax] Loss $25 million [before abnormals]
2.Beenup operations closed in February 1999
3.Write-offs [after tax] as follows:
· YEM ’98 $99 million
· YEM ‘99 $154 million
4.Review undertaken – As per letter from [BHPB] dated 9th July’99.
5.Transfer to another mining operations not feasible.
6.Claim against company for non-performance of supply contract – Approx $49m.
7.With the exception of some land which may realise a $2-$3 million above book value, all assets in the attached balance sheet are believed to be at realisable value.
8.Any future proceeds will be used to satisfy priority claims.
9.The prospects of servicing or repaying the loan from [Finance] are non-existent.
As a result, the critical issue is whether the loan from Finance to BHPDRI was “limited recourse debt” within the meaning of ss 243-20(1) or (2). It is to that issue that I now turn.
(e) Analysis
Limited recourse debt has been part of the repertoire of financiers for centuries. As early as 1857, the concept of limited rights of recovery by a mortgagee against a mortgagor was considered by the Courts of Exchequer: Mathew v Blackmore (1857) 156 ER 1409. In that case, a plaintiff brought an action to recover a sum of 200l lent by him to the defendant secured by a mortgage of certain lands. The plaintiff argued that the loan involved in it a liability to pay and subjected the borrower to an action of debt and that the mortgage – a charge upon the land to secure the debt – did not affect the right of the lender to sue the borrower for the whole of the debt. Pollock CB rejected the plaintiff’s argument. The Court held that:
the lending and borrowing of money is like any other contract, and that the right of the lender and the liability of the borrower depends upon the contract between them; and that there was no reason why in the case of a loan of money the ordinary rule should not apply, viz, that where the contract is reduced to writing in order to define and give evidence of the transaction between the parties, that the writing and the writing alone should regulate their respective rights and liabilities.
… and the presence of [a] covenant whereby the defendant covenanted to pay not absolutely but only out of such monies as should come to his hands, coupled with the fact that he was a mere trustee and had no personal interest in the transaction, shewed that it was never intended to create, as between him and the plaintiff, the relation of creditor and debtor as upon a simple loan of money.
The distinction between recourse and limited recourse debt was succinctly explained by the Supreme Court of Canada in McLarty v R (2008) 293 DLR (4th) 659 at [29] in the following terms:
In the context of debt, recourse means that the creditor has a right to repayment of a loan from the borrower, not just from the collateral that secured the loan. By contrast, non-recourse or limited recourse debt limits the creditor to the recovery of specified security. The creditor is not entitled to seek repayment from the borrower should the proceeds from the disposition of the security be less than the total indebtedness.
(emphasis added).
As it is a question of contract, it has no prescribed form. It depends upon what the parties have agreed or, in the modern world as the following cases illustrate, the creativity of those who put together financing packages and arrangements: see by way of example, Esanda v Burgess [1984] 2 NSWLR 139; NZI Capital Corporation Pty Ltd v Child (1991) 23 NSWLR 481, 489F; Guest v Federal Commissioner of Taxation (2007) 65 ATR 815, 819 at [11]; R v New Queensland Copper Co Ltd (1917) 23 CLR 495, 496, 501-2 (where the Queensland Government advanced money to a mining company that was to be “repaid out of the profits which shall hereafter be derived by or accrue to the company from the working of the said mines” and was therefore unable to seek to recoup the debt from the assets of the company); Federal Commissioner of Taxation v Sidney Williams (Holdings) Ltd (1957) 100 CLR 95, 115.7; Inland Revenue Commissioners v Herdman [1969] 1 All ER 495; Federal Commissioner of Taxation v Firth (2002) 120 FCR 450, 468 and Malouf v Federal Commissioner of Taxation (2008) 68 ATR 470, 477.
It is therefore not surprising that the drafters of Div 243 sought to define the phrase “limited recourse debt” and to define it in the way that they did. The issue is whether the loan from Finance to BHPDRI satisfied one or both of the drafters’ definitions of “limited recourse debt”. In my view, it did not.
Section 243-20(1)
The terms of and the circumstances surrounding the loan from Finance to BHPDRI are not in dispute: see [26] to [60] above.
The focus of s 243-20(1) is, first, to identify the existence of an obligation imposed by law on an entity (defined as the debtor) to pay an amount to another entity (defined as the creditor). In the case of BHPDRI, Finance’s standard terms (see [21] above) provided, in part, that:
b)Loans are to be made up of such amounts and are to be advanced on such dates as are agreed orally from time to time by the borrower and [Finance]. Each initial loan and each additional loan is to be for a period not exceeding five months at which time all loans shall become immediately repayable.
(emphasis added).
The Commissioner does not dispute the existence of this obligation on BHPDRI to repay to Finance the amounts advanced to or drawn down by BHPDRI together with any interest accrued on those amounts.
Having identified that obligation of BHPDRI to pay an amount to Finance, s 243-20(1) then requires identification of the “rights of the creditor” (Finance) “against the debtor” (BHPDRI) “in the event of default in payment of the debt or of interest” by BHPDRI. In the case of BHPDRI, Finance’s standard terms (see [21] above) were silent. Put another way, the standard terms did not address the rights of Finance against BHPDRI in the event of default directly or indirectly.
For that reason alone, it cannot be said that the rights of Finance against BHPDRI in the event of default were “limited wholly or predominantly” to any of the matters listed in sub-paragraphs (a) to (c) of s 243-20(1). Moreover, as a matter of contract, there is no basis for the implication of a term in the contract between Finance and BHPDRI limiting the rights of Finance wholly or predominantly to any of the matters listed in sub-paragraphs of s 243-20(1): BP Refinery (Westernport) Pty Ltd v Shire of Hastings (1977) 180 CLR 266, 283. Those sub-paragraphs of s 243-20(1) list what might be described as the common or more usual forms of limited recourse debt including: (a) rights in relation to the debt property or use of the debt property; (b) rights in respect of a mortgage or other security over the debt property or other property; and (c) rights arising out of any arrangement relating to the financial obligations of an end user of the financial property towards the debtor. Property is “debt property” if it is the “financed property” or the property provided as security for the debt: s 243-30(3) (see [199] above). Property is “financed property” if the debt was used wholly or partly to finance or refinance expenditure “on the property” or “on the acquisition of the property”, or that “results in the creation of the property or is otherwise connected with the property”: s 243-30(1) (see [199] above).
Finance’s rights in the event of default were not so limited. Finance’s standard terms did not limit “wholly or predominantly” the rights of Finance against BHPDRI in the event of default to any of the matters listed in sub-paragraphs (a) to (c) of s 243-20(1). BHPDRI’s obligation to Finance was unlimited except as to the amount of the debt or interest. Finance had a right to call for repayment of the principal and any interest that had accrued, to sue on the promise of repayment in the standard terms and then to prove with other unsecured creditors in the event of a winding up of BHPDRI: s 555 of the Corporations Act; Federal Commissioner of Taxation v Linter Textiles Australia Ltd (in liq) (2005) 220 CLR 592, 612-13 and Federal Commissioner of Taxation v Macquarie Health Corporation Ltd (1998) 88 FCR 451, 472. An unsecured creditor has no interest in or right to specific assets: Macquarie Health Corporation at 472.
Contrary to the conclusion I have reached, the Commissioner contends that s 243-20(1) “aptly describes the situation which existed as between BHPDRI and Finance”. Notwithstanding that the Commissioner conceded (as he had to) that:
1.BHPDRI’s obligations in respect of the loan from Finance were not secured either against its own assets or assets of any other entity; and
2.BHPDRI’s obligations in respect of the loan from Finance were not covered by guarantees, letters of comfort or assurances from any other entity; and
3.in the event of default in payment of the debt or interest, Finance was limited to the ordinary rights of an unsecured creditor,
the Commissioner maintained that contention on two bases.
First, the Commissioner contends that the noun “rights” when it first appears in s 243-20(1) must be limited to the rights in paras (a) to (c) and that the rights listed in those paragraphs need not contain any further limitation and, secondly, consistent with that construction of s 243-20(1), Finance’s practical rights of recovery or recourse against BHPDRI were wholly or at least predominantly limited to BHPDRI’s assets at the HBI plant at Boodarie.
The express words of Div 243 (and, in particular s 243-20(1)) (see [198] above) do not support the Commissioner’s construction. Moreover, if the construction contended for by the Commissioner were adopted it would lead to two absurd results. First, that one would assess whether a debt was a limited recourse debt not at the time that the loan was made or relevantly varied but when a project fails and secondly, that the debt of every unsecured creditor, regardless of the contractual arrangements between the parties, would be treated as “limited recourse debt”. Those results cannot be and were not the results intended by Parliament. Read as a whole, it is apparent that the definition of limited recourse debt in s 243-20(2) was intended to expand the concept beyond those recorded in contractual arrangements between a debtor and a creditor. If the Commissioner’s construction were adopted then much if not all of s 243-20 would be superfluous. Parliament could have simply referred to any arrangement where a project fails and the debtor does not repay the advance. That is not what occurred.
If further support for that conclusion is necessary (and I consider that it is not), it is to be found in the scheme of Div 243 as a whole. As noted earlier, it applies to cancel capital allowance deductions claimed by a taxpayer and include the value of those deductions in the assessable income of the taxpayer when the relevant debt arrangement is terminated. Assessment of whether or not the Division might potentially apply to a particular arrangement should be able to be assessed at the time of the original capital allowance deduction, not simply if and when a project fails for whatever reason.
Moreover, even if the Commissioner’s construction were adopted (and I do not adopt it), there is some doubt about the accuracy of the factual premise in the present case. Namely, that Finance’s practical rights of recovery or recourse against BHPDRI were wholly or at least predominantly limited to BHPDRI’s assets at the HBI plant at Boodarie. A list of the property of BHPDRI was tendered in evidence and included licences and intellectual property. It was by no means clear that all of that property was located at or connected with the plant at Boodarie.
Financed property / debt property
Before leaving s 243-20(1) of the 1997 Act, it is necessary to turn to consider the concept of “financed property” in s 243-20(1)(c). As noted above (see [197] – [199] and [212]), it is a defined term. Property is “debt property” if it is “financed property” and property is “financed property” “if the expenditure referred to in s 243‑15(1)(a) is on the property, is on the acquisition of the property, results in the creation of the property or is otherwise connected with the property”: s 243-30. What is the “expenditure” to which s 243-15(1)(a) is referring and what is the “property” to which s 243-30 is referring?
The answer to the first question is straightforward. “Expenditure” appears twice in s 243-15(1) in subsections (a) and (c). Those subsections direct attention to two matters. First, whether limited recourse debt has been used to wholly or partly finance or refinance expenditure (sub-s (a)) and, if so, whether the debtor can deduct an amount as a capital allowance (under Div 40) in respect of that expenditure or the financed property (sub-s (c)). Having regard to the views that I have formed about the absence of limited recourse debt (see [205] to [218] above), there can be no “financed property”. However, if I am wrong in my conclusion about the nature of the Finance / BHPDRI loan facility not being limited recourse debt, in my view the taxpayers have failed to establish that the property on which the funding was expended was not “debt property”. Put another way, the taxpayers failed to identify the source of funding to acquire the property: see ss 14ZZO(b) of the TAA; Federal Commissioner of Taxation v Dalco (1990) 168 CLR 614; Australian and New Zealand Savings Bank Ltd v Federal Commissioner of Taxation (1992) 92 ATC 4630. That conclusion requires some explanation.
The applicants do not dispute that the quantum of capital expenditure on the assets of BHPDRI was recorded in the books of account of BHPDRI and totals approximately $2.16 billion for the period from 1 June 1995 to 30 June 2000.. However, it is also common ground that that total is somewhat misleading because it includes amounts capitalised for accounting purposes that were not the subject of a capital allowance under Div 40 and does not include amounts which gave rise to capital allowances under Div 40 but which were not capitalised for accounting purposes. The difficulty faced by the applicants in the present case is that the property of BHPDRI acquired by BHPDRI during the period from 1 June 1995 to 30 June 2000 was funded by the loan from Finance and from subscriptions of equity. The applicants submitted that because the property was acquired from “multiple funding sources” it was necessary to compare the change in debt funding of the company during the period in which the expenditure on that property was incurred with the amount of that expenditure. The flaw in the contention is exposed by the applicants’ submission that:
Where the funding available to [BHPDRI] in a particular month exceeded the capital expenditure, it cannot be concluded that the expenditure was funded by debt if there were other sources of funding that were sufficient to meet the expenditure. An example of this arises in June, July and August 1995. In those months capitalised expenditure totalled $18,774,979. At that time, [BHPDRI] had available to it $20,000,000 share capital, and the only other expenses [BHPDRI] incurred in that period totalled $162,901. … None of the assets acquired by this expenditure was debt property because it cannot be concluded that any of that expenditure was financed by debt, limited recourse or otherwise.
One only has to state the proposition to realise the flaws in it. First, there was no and could be no direct correlation between debt funding and expenditure on a month to month basis. Funds could have been supplied in one month from one source and used months if not years later. Moreover, the total capital expenditure recorded in BHPDRI’s books of accounts (subject of course to the difficulties identified earlier) was in excess of $2 billion. The applicants do not and cannot dispute that the total BHPDRI – Finance debt by the 2000 year had reached in excess of $2.1 billion. At the same time, the total of the other funding sources (whether by equity contributions or otherwise) did not exceed $500 million. Thirdly, contrary to the applicants’ submissions, s 243-15(1)(a) requires that the debt be used to “wholly or partly” finance or refinance the expenditure. And, fourthly, the concept of expenditure and property is itself expanded in s 243-30(1) which provides that property is the financed property if the “expenditure” referred to in paragraph 243-15(1)(a) is “on the property, is on the acquisition of the property, results in the creation of the property or is otherwise connected with the property”.
In the present case, the applicants concede that there probably was expenditure entirely funded by debt in some months (eg September and October 1995) but do not identify or even attempt to identify the capital expenditure and, in particular, the nature of the property acquired. This form of analysis is, in my view, necessary because of the expanded definition of expenditure in s 243-30(1). That section directs a broad enquiry beyond a mere identification of the property to consideration, inter alia, of expenditure on items otherwise connected with the property. That enquiry is made all the more difficult in the present case, because the “property” in the most general terms consists of numerous items of plant and equipment as well as allegedly personal items of property, some or all of which comprise the HBI plant. On the basis of the current evidence, one can infer from the amount and timing of the debt funding, the quantum of the capitalised expenditure on the assets of BHPDRI recorded in the books of account of BHPDRI, the asset register of BHPDRI and the timing of that expenditure, that the debt funding has been used to wholly or partly finance or refinance expenditure (sub-s (a)) and that BHPDRI did deduct an amount as a capital allowance (under Div 40) in respect of some of that expenditure or the financed property: ss 243-15(1)(a), (1)(c). On no view is it possible for those amounts to be quantified with any precision.
Although I have ultimately decided the question on the basis that the applicants failed to discharge their onus, the answer may in fact lie elsewhere. On one view, the dilemma faced by the applicants supports the construction of Div 243 that I have adopted – Div 243 was never intended to apply to arrangements such as those the subject of these proceedings. The alternative is that taxpayers claiming capital allowances under Div 40 should be in a position to identify each capital allowance, the source of funding for each capital allowance and the inter-connectedness (if any) between items of expenditure. I can only suspect that the applicants did not undertake that or a similar exercise in the present case because such an exercise was not only expensive but would have inevitably lead to the conclusion that the debt funding had been used to wholly or partly finance or refinance expenditure and that BHPDRI did deduct an amount as a capital allowance (under Div 40) in respect of some of that expenditure or the financed property: ss 243-15(1)(a), (1)(c).
Section 243-20(2)
Alternatively, the Commissioner relies upon s 243-20(2) of the 1997 Act. BHPB conceded that s 243-20(2) extends the definition of “limited recourse debt” (see [198] above).
The language of s 243-20(2) is important and should be restated.It builds on subsection (1). It expands the category of obligations imposed by law on a debtor that will constitute limited recourse debt under sub-s (1) where:
it is reasonable to conclude that the rights of the creditor as against the debtor in the event of default in payment of the debt or of interest are capable of being limited in the way mentioned in subsection (1).
(emphasis added).
In reaching this conclusion, the section provides that regard is to be given to:
(a) the assets of the debtor (other than assets that are indemnities or guarantees provided in relation to the debt);
(b) any *arrangement to which the debtor is a party;
(c) whether all of the assets of the debtor would be available for the purpose of the discharge of the debt (other than assets that are security for other debts of the debtor or any other entity);
(d) whether the debtor and creditor are dealing at *arm's length in relation to the debt.
Subsection (2) is clearly intended to catch those debts which bear no existing legal limitation of the kind specified in subsection (1) but where “it is reasonable to conclude that the rights” in the event of default are “capable” of being limited to those rights specified in sub-s (1). As the applicants submitted, subsection (2) is intended to catch those arrangements which have the capacity to bring about the limitation described in sub-s (1). The form of that capacity is, unsurprisingly, broad and extends, for example, to “any *arrangement to which the debtor is a party”. It is an objective test. Whether the capacity of the kind described exists is, of course, a question of fact to be resolved having regard to the matters listed in paragraphs (a) to (d) of sub-s (2). As the earlier analysis of the cases dealing with limited recourse debts demonstrates there is no and can be no prescribed form for such arrangements.
However, I do not consider that s 243-20(2) adopted or incorporated a test of economic equivalence (such as that adopted in Div 974 of the 1997 Act). That was the substance if not the form of the Commissioner’s submissions – that the section necessitates an assessment of whether more than 50% of the property owned by the debtor is related to property acquired with the relevant loan proceeds. If that were the correct approach (which I reject) the result would be that funding arrangements at the start of a business would be limited recourse within Div 243 and would then fall in or out of the division depending on whether the venture was a success or a failure. The terms of the funding arrangements (whether limited in the sense of sub-s (1) or considered more broadly under sub-s (2)) would simply be irrelevant. That is not consistent with the express words of the section. If the drafters had intended the issue to be approached in that manner, they would have said so. They did not.
Moreover, the express words of sub-s (2) are themselves inconsistent with a test of economic equivalence. Under sub-s (2), one of the matters to consider in deciding whether the specified limitation is “capable” of being limited in the manner described is “whether all of the assets of the debtor would be available for the purpose of the discharge of the debt”: s 243-20(2)(c). In my view, that matter is not a factor or pointer in favour of the section adopting or incorporating a test of economic equivalence. On the contrary, consistent with sub-s (1) and the evident purpose of the legislature to seek to define “limited recourse debt”, it is to be inferred that where all of the assets of the debtor are available for the purpose of the discharge of the debt (other than assets that are security for other debts of the debtor or any other entity) that would be a factor supporting the conclusion that the rights of the creditor against the debtor in the event of default were not capable of being limited in the manner specified.
The interaction between Div 243 and Div 245 provides further support for the rejection of the proposition that s 243-20(2) adopted or incorporated a test of economic equivalence. Div 245 in Schedule 2C of the 1936 Act was inserted in the tax legislation to address a “structural weakness”: Second Reading Speech to the Taxation Laws Amendment Act (No 2) 1996. Prior to the introduction of Div 245, on forgiveness of a debt a creditor was entitled to a bad debt deduction or a capital loss and the debtor would continue to be entitled to deduct losses accumulated before the debt was terminated and to claim capital allowance deductions for expenditure funded by the forgiven debt. In other words, both the debtor and the creditor enjoyed a deduction for the same economic loss in relation to a bad debt. That “weakness” was addressed by Div 245. In fact, in the present case, BHPDRI applied Div 245 when it lodged its returns to the bad debt written off by Finance.
On the other hand, Div 243 (introduced some three years later) is not concerned with or directed to the economic benefit to a taxpayer if a debt is forgiven. Div 243 is directed to the specific case where a taxpayer is not personally at risk in relation to borrowed funds used to finance an item of capital. In general terms, the measures were introduced to address not a case of double deductions for the same debt (by two different taxpayers) but the situation where a taxpayer obtained deductions greater than the total amount outlaid by that taxpayer in relation to capital expenditure under hire purchase or limited recourse debt arrangements primarily in cases where the balance of an outstanding debt that had financed the expenditure was not paid and the financier could only recover a specific asset on termination of the finance arrangement: paras 2.6-2.9 of the Explanatory Memorandum to Taxation Laws Amendment Bill (No 5) 1999 (Cth).
(f) Conclusions about Div 243
As these reasons for decision demonstrate, Div 243 has no application to BHPDRI’s debt with Finance. The preconditions to the Division applying set out in s 243-15(1) are not satisfied. Limited recourse debt was not used to wholly or partly finance or refinance expenditure.
G. ADDITIONAL TAX
As noted earlier (see [5(5)] above), this question of additional tax does not arise. However, if I am wrong in reaching the conclusions set out above, I do not consider that the position adopted by any of the taxpayers was not “reasonably arguable”. It is common ground that whether a matter is “reasonably arguable” is a question to be determined objectively: Walstern v Federal Commissioner of Taxation (2003) 138 FCR 1, 26; Pridecraft Pty Ltdv Federal Commissioner of Taxation (2004) 213 ALR 450 at [108]-[109]; Federal Commissioner of Taxation v R & D Holdings Pty Ltd (2007) 160 FCR 248, 260-61 and Cameron Brae Pty Ltd v Federal Commissioner of Taxation (2007) 161 FCR 468, 488.
A reasoned argument was and can be made to support the contention that the various substantive tax laws should apply in the manner contended for by the applicants. In relation to Div 243, the position is far stronger – this was the first decision concerning that division.
H. CONCLUSIONS AND ORDERS
I do not propose to make final orders. Instead, I will direct the parties to confer and jointly file short minutes of proposed orders giving effect to these reasons by 4:00 pm on 3 April 2009. If the parties are unable to agree, they are to submit a joint statement by 4:00 pm on 3 April 2009 identifying: (1) the point(s) of agreement; (2) the point(s) of disagreement; and (3) the respective positions of the parties on the point(s) of disagreement, in which case I will list the matter for further directions or hearing as necessary. If further directions or hearing are sought, the parties should consult amongst themselves and then contact my chambers with a list of mutually agreeable dates and an estimated time required for the proposed directions or hearing.
I certify that the preceding two hundred and thirty six (236) numbered paragraphs is a true copy of the Reasons for Judgment herein of the Honourable Justice Gordon Associate:
Dated: 30 March 2009
Counsel for the Applicant: DH Bloom QC, with J de Wijn QC, SHP Steward & K Deards Solicitor for the Applicant: Mallesons Stephen Jaques Counsel for the Respondent: H Symon SC with M Flynn & L Armstrong Solicitor for the Respondent: Australian Government Solicitor
Date of Hearing: 29 and 30 January and 2, 4-6 February 2009 Date of Judgment: 30 March 2009
SCHEDULE “A” – PAR [21] OF THE REASONS FOR DECISION
Loan Balances Company 1995 1996 Principal Company Activities 1. BHP Limited 676.1 1,354.5 Holding company, Iron and Steel Production and Mining 2. AWI Holdings Pty Ltd 119.2 163.1 Holding company for the Australian Wire Industries group which was engaged in the manufacture of wire, wire ropes, and fence posts primarily for farming. 3. BHP Australia Coal Pty Ltd 2,711.0 4,606.0 Coal mining, minerals exploration and manager 4. BHP Direct Reduced Iron Pty Ltd - 54.7 Development of HBI plant 5. BHP Engineering Pty Ltd 23.7 22.5 Engineering service company 6. BHP Information Technology Pty Ltd 27.6 21.4 Information Technology manager for the BHP Group and supply of computer services 7. BHP International Holdings Limited 6.2 10.3 Holding company and China representative office (Australian resident) 8. BHP Iron Ore Pty Ltd 2.8 22.2 Provided Management and Marketing services to the Australian Iron Ore business. 9. BHP Iron Pty Ltd 15.3 - Holds leases relating to the Goldsworthy Joint Venture and iron ore mining. 10. BHP Materials Pty Ltd 99.8 - Steel Trading company for Steel activities. It initially marketed redundant equipment on behalf of the Steel Group. Also involved in diverse activities such as timber importation. 11. BHP Minerals Pty Ltd 433.9 704.5 Iron ore and coal mining company 12. BHP Petroleum Pty Ltd 3,921.4 5,775.4 Management company 13. BHP Petroleum (Bass Strait) Pty Ltd 30.3 60.0 Supplier of Oil and Gas from Bass Strait as part of the Esso/BHP Joint Venture – Hydrocarbons, exploration, development and marketing. 14. BHP Queensland Coal Limited 2.9 - Coal Mining activities in Queensland. 15. BHP Rail Products Pty Ltd 1.9 - Based in both Adelaide and Whyalla, this company produced and marketed steel rail sleepers and the fasteners that attach the rails to the sleepers. Marketed under the TrakLok Brand. 16. BHP Refractories Pty Ltd 65.7 82.8 Manufacture and installer of refractory (brick) linings for use in the repair or construction of furnaces and ladles. The material was used primarily in steel blast furnaces and smelting operations. 17. BHP Steel (AIS) Pty Ltd 965.9 2,237.3 Involved in coal mining, coke making, sinter production, Iron and Steelmaking and the casting of steel into slabs and the rolling of slabs into plates (for ship building) and hot strip coils for use in coil plate, tinplate and black plate manufacture. 18. BHP Steel (JLA) Pty Ltd 409.2 818.0 Acquires slabs and hot strip from BHP Steel (AIS) Pty Ltd and rolls the material (roll forming) into longer flat material which is then coated as zincalum or colourbond products. 19. BHP Transport Pty Ltd 334.7 351.4 BHP Transport owned and operated a fleet of ships to service BHP’s import and export businesses. This company also chartered ships as part of its mandate to provide transport services. 20. BHP Titanium Minerals Pty Ltd 39.6 188.8 Titanium minerals mining and holding company. 21. Groote Eylandt Manganese Sales Pty Ltd 15.5 10.5 Marketing company for Manganese ore. Participated in the Elkem joint venture for the processing of manganese ore in Norway. 22. Groote Eylandt Mining Co Pty Ltd 94.7 225.3 Mining and sale of Manganese Ore a feed product for ferro manganese production. The manganese ore is further processed within the Group by Tasmanian Electro Metallurgical Company Pty Ltd. 23. Pilbara Energy Pty Ltd 26.8 114.9 Power Generation to provide gas based electricity generation into the Port Hedland area where BHP operated the Nelson Point and Finucane Island iron ore processing and shiploading operations. 24. Queensland BHP Steel Pty Ltd - 5.1 It transformed steel billets by rolling them into products required by the market in South Eastern Queensland. Products included rods used in concrete construction activities and steel bars. 25. Tasmanian Electro Metallurgical Co. Pty Ltd 29.8 20.3 Ferro alloy manufacturer and marketing. 26. Tubemakers of Australia Limited - 202.2 Manufacture of steel pipe and tube and merchandising of Steel products. TOTAL 10,054.0 17,051.2
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