Commissioner of Taxation v Consolidated Press Holdings Ltd (No 1)
[1999] FCA 1199
•7 September 1999
Commissioner of Taxation v Consolidated Press Holdings Limited, Murray Leisure Group Pty Limited and CPH Property Pty Limited (No. 1) [1999] FCA 1199
Taxation and Revenue
(1999) 91 FCR 524, (1999) 166 ALR 1
Commissioner of Taxation v Consolidated Press Holdings Ltd [1999] FCA 1199
COMMISSIONER OF TAXATION v CONSOLIDATED PRESS HOLDINGS LIMITED (ACN 008 394 509), MURRAY LEISURE GROUP PTY LIMITED
(ACN 000 090 273) and CPH PROPERTY PTY LIMITED (ACN 000 031 747)
NG 1172, 1173, 1174 and 1175 of 1998
FRENCH, SACKVILLE AND SUNDBERG JJ
7 SEPTEMBER 1999
SYDNEY
TAXATION AND REVENUE - income tax - tax avoidance - outgoings incurred in relation to foreign source income - application of quarantining provisions of s 79D - application where zero foreign source income - transactions to avoid application of s 79D in connection with financing of proposed takeover - whether a scheme under Part IVA - provision held to apply to case of zero foreign source income - scheme for purpose of tax benefit - Part IVA applicable.
Dividend stripping scheme - corporate reorganisation - relocation of holding structure from United Kingdom to Bahamas - commercial purpose unrelated to tax benefit from dividend stripping - no dominant purpose of tax avoidance - s 177E and Part IVA inapplicable.
Income Tax Assessment Act 1936 (Cth), ss 46, 46A, 46B, 47(1), 51, 79D, 102L(3), 102T(3), 160AFD, 160APHA, 160APP, 160AQT, 160ARDCA, 177A, 177C, 177D, 177E, 177F, 260
Income Tax Laws Amendment Act (No 2) 1981 (Cth)
Income Tax Assessment Act (No 3) 1972 (Cth)
Federal Commissioner of Taxation v Spotless Services Ltd (1996) 186 CLR 404, followed
AGC (Advances) Ltd v Federal Commissioner of Taxation (1975) 132 CLR 175, cited
Esquire Nominees Ltd v Federal Commissioner of Taxation (1973) 129 CLR 177, distinguished
Thiel v Federal Commissioner of Taxation (1990) 171 CLR 338, referred to
Federal Commissioner of Taxation v Peabody (1994) 181 CLR 359, cited
Inland Revenue Commissioners v Brebner [1967] 2 AC 18, cited
Peabody v Federal Commissioner of Taxation (1993) 40 FCR 531, cited
CIC Insurance Ltd v Bankstown Football Club Ltd (1997) 187 CLR 384, cited
Cooper Brookes (Wollongong) Pty Ltd v Federal Commissioner of Taxation (1981) 147 CLR 297, cited
Saraswati v The Queen (1991) 172 CLR 1, cited
Investment and Merchant Finance Corporation Limited v Federal Commissioner of Taxation (1970) 120 CLR 177, discussed
Investment and Merchant Finance Corporation Limited v Federal Commissioner of Taxation (1971) 125 CLR 249, cited
Federal Commissioner of Taxation v Patcorp Investments Ltd (1976) 140 CLR 247, discussed
Bell v Federal Commissioner of Taxation (1953) 87 CLR 548, cited
Newton v Federal Commissioner of Taxation (1958) 98 CLR 1, cited
Hancock v Federal Commissioner of Taxation (1961) 108 CLR 258, cited
Federal Commissioner of Taxation v Ellers Motor Sales Pty Ltd (1972) 128 CLR 602, cited
Rowdell Pty Ltd v Commissioner of Taxation (1963) 111 CLR 106, cited
John v Federal Commissioner of Taxation (1989) 166 CLR 417, cited
Slutzkin v Federal Commissioner of Taxation (1977) 140 CLR 314, cited
Harrison v Federal Commissioner of Taxation (1977) 77 ATC 4144, cited
Hennessey v Federal Commissioner of Taxation (1975) 10 SASR 353, cited
Federal Commissioner of Taxation v Newton (1957) 96 CLR 577, cited
K Porter & Co Pty Ltd v Federal Commissioner of Taxation (1977) 19 ALR 510, cited
Federal Commissioner of Taxation v Students World (Australia) Pty Ltd (1978) 138 CLR 251, cited
Woellner, Vella, Burns, Barkoczy and Krever, Australian Taxation Law (9th ed 1999)
Vincent, "Dividend Stripping: stricto sensu or strictly senseless" (1989) 24 Taxation in Australia 82
IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY NG 1172 of 1998 1173 of 1998
1174 of 1998
1175 of 1998
ON APPEAL FROM A SINGLE JUDGE OF THE FEDERAL COURT
c COMMISSIONER OF TAXATION Appellant
AND: CONSOLIDATED PRESS HOLDINGS LIMITED (ACN 008 394 509)
MURRAY LEISURE GROUP PTY LIMITED (ACN 000 090 273) CPH PROPERTY PTY LIMITED (ACN 000 031 747)
Respondents
JUDGES: FRENCH, SACKVILLE AND SUNDBERG JJ DATE OF ORDER: 7 SEPTEMBER 1999 WHERE MADE: SYDNEY
THE COURT ORDERS THAT:
A. In each of the Appeals NG 1174 of 1998 and NG 1175 of 1998:
1. The appeal is allowed.
2. The decision and orders of the learned trial judge are set aside and in lieu thereof the application to the learned trial judge is dismissed.
3. The Respondent, CPH Property Pty Ltd, is to pay the costs of this appeal and the application.
B. In each of the Appeals NG 1172 of 1998 and NG 1173 of 1998:
1. The appeal is dismissed.
2. The Appellant is to pay the Respondents' costs of the appeal.
Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.
IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY NG 1172 of 1998 1173 of 1998
1174 of 1998
1175 of 1998
ON APPEAL FROM A SINGLE JUDGE OF THE FEDERAL COURT
BETWEEN: COMMISSIONER OF TAXATION Appellant
AND: CONSOLIDATED PRESS HOLDINGS LIMITED (ACN 008 394 509)
MURRAY LEISURE GROUP PTY LIMITED (ACN 000 090 273) CPH PROPERTY PTY LIMITED (ACN 000 031 747)
Respondents
JUDGES: FRENCH, SACKVILLE AND SUNDBERG JJ DATE: 7 SEPTEMBER 1999 PLACE: SYDNEY
REASONS FOR JUDGMENT
Introduction
1 Consolidated Press Holdings Ltd ("CPH"), CPH Property Pty Limited, formerly known as Australian Consolidated Press Limited ("ACP"), and Murray Leisure Group Pty Ltd ("MLG") are all part of the Consolidated Press Group of Companies ("the Group"). CPH is the holding company for the Group and its ultimate shareholder is a private company owned by Mr Kerry Packer. These appeals concern the amounts of assessable income for tax purposes earned by each of the companies in the following years of income:
CPH - year ended 30 June 1990
ACP - years ended 30 June 1989 and 30 June 1991
MLG - year ended 30 June 1990
The issues raised by these appeals concern the application of Part IVA of the Income Tax Assessment Act 1936(Cth)("ITAA") to what is said to be a scheme whereby deductions relating to foreign source income are offset against taxable income. Those issues are raised in the two appeals relating to ACP. The other appeals involve the issue of dividend stripping, for which Part IVA makes specific provision in s 177E.
Factual Background in Outline
2 In April 1989, the Group initiated steps with a view to making a takeover bid for a United Kingdom company, BAT Industries Plc ("BAT"). The bid was to be made in conjunction with interests associated with Sir James Goldsmith and Mr Jacob Rothschild. It was anticipated that capital in the order of 250 million pounds sterling would be required. The relevant principals of the Group believed that the BAT takeover would yield substantial profits flowing from Consolidated Press International Ltd ("CPIL(UK)"). The expected profit was approximately one billion pounds sterling.
3 There were at that time two member companies of the Group which were incorporated in the United Kingdom, namely CPIL(UK) and Consolidated Press International Holdings Ltd ("CPIHL(UK)"). Their shares were entirely beneficially owned by CPH. Under the tax laws of the UK, each company was a UK non-resident, since its central management and control were outside the UK. Since neither company was a resident of the UK, it was not liable to pay UK tax on its world wide income. At the relevant times, the boards of directors of CPIL(UK) and CPIHL(UK) included Mr Kerry Packer and, as the primary judge put it, "various high profile individuals" resident in the UK, the United States and elsewhere.
4 It was necessary to arrange finance for the takeover. Mr D. Bourke, who was at that time the Financial Controller of ACP, had already obtained advice from Mr J. Cherry of Arthur Young, in August 1988, about the most advantageous means of channelling borrowings through to CPIL(UK) and CPIHL(UK). That advice had been received in connection with an unrelated refinancing proposal flowing from an earlier acquisition of the Valassis Group of companies which were American owned. The refinancing proposal had not proceeded. The same advice however was offered in relation to the funding of the BAT takeover and it was followed.
5 Central to that repeated advice, of which no record was kept, was the proposition that instead of funds borrowed by the Group being advanced directly to the company or companies which were to act as takeover vehicles, ACP should use the money to subscribe for shares in MLG. That company could in turn invest the funds raised by the issue of its shares to ACP in a new issue of redeemable preference shares by CPIL(UK). The latter company would then advance the funds to the takeover vehicle via some foreign structure. The "foreign structure" in this case was CP Investment (Singapore) Pte Ltd ("CPI(Sing)") which was incorporated in Singapore on 11 October 1988. This last element had to do with double tax treaties and interest withholding tax in the United Kingdom and not with Australian tax. The takeover vehicle was to be Hoylake Investments Ltd ("Hoylake"), a company incorporated in the Bahamas.
6 The advice from Arthur Young indicated, inter alia, that the suggested mix of borrowing and share subscription would obviate the effects of a proposed change to the law foreshadowed by the Australian Government with the issue of a consultative document on 25 May 1988. This proposed that, as from the 1989/90 tax year, the income of non-resident entities in which Australian residents had an interest should be taxed on an accruals basis, where the income was derived from low-tax countries. The consultative document contemplated that the use of indirect ownership rules by countries that enacted accruals legislation could entail the income of a particular foreign entity being subject to more than one country's tax legislation. In other words, the document contemplated the possibility of double taxation, although it was said that consideration would be given to the need for relief.
7 The steps taken by the Group in implementation of the advice with a view to the takeover of BAT, and their immediate sequelae, were as follows:
1. 28 April 1989 - ACP applied for and was allotted 600,000 redeemable preference shares at $1 each at a premium of $500 per share in the capital of MLG. The subscription price was $A300.6 million.
2. 2 May 1989 - Consolidated Press (Finance) Ltd ("CPF") lent ACP $A300.6 million to enable the share subscription to proceed.
3. 5 May 1989 - Westpac Banking Corporation advanced $US240 million to CPH.
4. 5 May 1989 - CPIL(UK) allotted 2,400,000 fully paid ordinary shares of $US100 each to MLG. This was funded from moneys advanced to CPH by Westpac.
5. 21 June 1989 - CPI(Sing) subscribed for 195 ordinary shares of GBP1 each in Hoylake at a premium paying GBP8,835,125 to Hoylake representing 32.5% of the Hoylake shares. The balance was held by interests associated with Goldsmith and Rothschild.
6. 10 July 1989 - MLG lent $US100 million interest free to CPIL(UK), equivalent to $A131,483,585.03. The funds came from the CPF US Dollar account with Westpac in the US and were treated as an advance by CPF to ACP to enable ACP to pay for the redeemable preference shares in MLG.
7. CPIL(UK) immediately lent the $US100 million to CPI(Sing) initially described as interest free. Nevertheless interest was charged at 15% pa until 6 October 1989 and thereafter at 16.25% pa.
8. 11 July 1989 - a formal bid was announced in a press release.
9. 28 November 1989 - the funds lent by MLG to CPIL(UK) were used to pay for one million redeemable preference shares of $US100 each in CPIL(UK), allotted to MLG on that day.
10. April 1990 - the California Department of Insurance refused approval for the sale of Farmers Group Inc, which was a condition of the Hoylake bid.
11. 20 April 1990 - MLG's tax return for the year ended 30 June 1989 proceeded on the basis that s 79D of the ITAA as it then stood, applied.
12. 23 April 1990 - the bid for BAT was withdrawn.
13. 5 June 1990 - Hoylake went into voluntary liquidation.
8 In seeking advice about the foreshadowed Australian legislation from Mr Cherry in December 1989, Mr C.K. Mackenzie on behalf of the Group, indicated that he was "not particularly interested in avoiding the attribution of income, as seems to be the basic thrust and purpose of the new accruals legislation". He was "more concerned with the possibility that the group could suffer double taxation and/or be taxed in foreign jurisdictions to the detriment of the franking credits available to the ultimate parent corporation". A draft of the legislation was available in January 1990. Mr Cherry's advice was to relocate the holding companies from the UK to a tax haven.
9 By way of background, it should also be noted that on 15 March 1988 the UK Chancellor had announced proposed changes to tax legislation affecting non-resident UK companies such as CPIL(UK) and CPIHL(UK). The text of the announcement, relevantly, was as follows:
"-companies incorporated in the UK will be resident here for tax purposes. If these companies transfer their trade or business to non-resident companies, the existing rules to determine tax liability including that on capital gains will apply.-companies incorporated in the UK before today but not resident here under existing rules will become resident here only after five years from today unless central management and control of the company is transferred to the UK in the interim.
..."
The announcement therefore contemplated a five year period of grace, during which management and control of the company would be transferred to the UK. After that time, a company incorporated in the UK, whether or not resident under previous rules, would be taxed on world-wide income.
10 On 22 March 1990, a meeting of directors of CPIL(UK) and CPIHL(UK) resolved to recommend to members that each company be placed in voluntary liquidation and that an extraordinary general meeting of members be called on 11 April 1990 to that end. The directors of each company also resolved to declare dividends payable to members on 8 May 1990 in relation to both ordinary and redeemable preference shares. The totals of the dividends declared payable by the directors of CPIL(UK) and CPIHL(UK) were $US100,000,000 and $US53,000,000 respectively. The stated aim of the final holding structure set out in the papers from the Directors' meeting was
"...to ensure that the passive income referred to earlier is attributed to Australia as thereby franked dividends may be paid to the shareholders, ie dividends which will be tax free in the shareholders' hands". (emphasis in original)
Replacement of the UK companies with entities based in the Bahamas or Bermuda would ensure that the passive income flowed tax free to Australia and that there was no possibility of double taxation. The term "passive income" is defined in s 446 of the ITAA and includes income by way of dividend.
11 In the event, the new holding structure was located in the Bahamas. Companies were incorporated there on 5 April 1990 under the names Consolidated Press International Holdings Ltd ("CPIHL(B)") and Consolidated Press International Ltd ("CPIL(B)"). On 12 April 1990, MLG and CPH agreed to sell some of their holdings in CPIL(UK) and CPIHL(UK) to CPIL(B). The consideration for the transfer of those holdings was to be by way of ordinary A class shares of $US1 in the capital of CPIL(B), in accordance with a valuation prepared by Ernst & Young. On this basis, a meeting of a committee of directors of CPIL(B) on 27 April 1990 determined that 452,346,000 shares would issue to CPH and 118,287,000 to MLG. No transfers to give effect to the agreements were ever registered in a Register of Members of either CPIL(UK) or CPIHL(UK), nor did the directors of either company approve any transfer or resolve to direct registration.
12 A further agreement for the sale by MLG of shares in CPIL(UK) to CPIL(B) was made on 7 May 1990. The number of shares was 2,400,000 fully paid at $US100 each. The consideration was 262,338,319 shares of $US1 each in CPIL(B), based on an Ernst & Young valuation of the same date. The separation of the sale of these shares from those the subject of the agreement of 12 April related to the timing of their acquisition and the incidence of Australian capital gains tax in relation to them.
13 On 31 March 1990, an entry was made in the general ledger of CPIL(UK), debiting the $US100,000,000 payable by that company on 8 May 1990. A similar entry was made in the general ledger of CPIHL(UK) on 20 April 1990 in respect of the $US53,000,000 payable by it on 8 May 1990.
14 On 16 May 1990, the two United Kingdom companies resolved to go into voluntary liquidation and liquidators were appointed on that day. The members of each company also resolved to authorise the liquidators to distribute the whole or any part of their assets to the members in specie. On the same day, each of CPH and MLG by its duly authorised attorney, authorised and directed the liquidators of CPIL(UK) and CPIHL(UK) to pay direct to CPIL(B):
"(a) any payments consequent upon the crediting of dividends declared by the Company on 8th May, 1990; and(b) any distributions to members of the Company in the course of the winding up of the Company in respect of shares presently registered in the register of members in our name,
direct to [CPIL(B)] in place of any payment or distribution to us."
The direction may have been thought necessary because CPIL(B) at this time had not yet become registered as a member of either CPIL(UK) or CPIHL(UK).
15 On 17 May 1990, the liquidators of CPIHL(UK) assigned to CPIL(B) the first $US53,000,000 of a debt of $US84,220,334.05 due to CPIHL(UK) by Conpress (Singapore) Pte Ltd. This was expressed to be in full and final satisfaction of the liability of CPIHL(UK) to pay CPIL(B) the sum of $US53,000,000 by reason of the declaration of dividend payable on 8 May 1990. Similarly, on the same day, the liquidators of CPIL(UK) assigned to CPIL(B) the first $US106,751,299.80 of a debt due to CPIL(UK) from CPI(Sing). This was expressed to be, as to part, a payment by CPIL(B) on behalf of CPIL(UK) of the $US100 million dividend payable on 8 May 1990.
16 On 8 June 1990, the liquidators of CPIHL(UK) and CPIL(B) agreed that the liquidators would distribute in specie to CPIL(B) the balance of CPIHL(UK)'s assets. The assets of CPIHL(UK) identified in the agreement were certain shares held by the company and debts due to it by CPI(Sing) and another company. By a deed of assignment executed the same day, CPIHL(UK), by its liquidators, assigned the debts (totalling $US183,334,200.02) to CPIL(B).
17 CPH, in its income tax return lodged for the year of income ended 30 June 1990, returned a net assessable capital gain in relation to the sale of shares in CPIL(UK) and CPIHL(UK) as follows:
(i) Sale of shares in CPIHL(UK) $A12,737,013
(ii) Sale of shares in CPIL(UK) ( 1,225,608)
$A11,511,405
18 MLG, in its income tax return lodged for the year of income ended 30 June 1990, returnable assessable capital gains in relation to the sale of shares in CPIL(UK) as follows:
(i) Sale of shares in CPIL(UK) on 12 April 90 $A22,696,550
(ii) Sale of shares in CPIL(UK) on 7 May 90 17,436,403
$A40,132,953
19 Assessments of income tax issued variously to CPH, MLG and ACP for the years of income ended 30 June 1990 and 30 June 1991 and are the subject of these proceedings. The assessment for the year ended 30 June 1990, which issued to CPH on 21 December 1994, adjusted the net loss of $52,742,535 set out in its income tax return to a taxable income of $83,423,359. The adjustment was effected by deeming dividends to have been received from CPIL(UK) and CPIHL(UK). On 21 December 1994, the delegate of the Commissioner made a determination for the purposes of s 177F(1) of the ITAA in respect of CPH. The Commissioner determined that CPH, in the year of income ended 30 June 1990, had obtained, or would but for the operation of s 177F have obtained, a tax benefit of two amounts, namely $69,681,830 and $49,726,875, being amounts which would not otherwise have been included in CPH's assessable income.
20 Although the determination did not say so, the sum of $69,681,830 was the Australian dollar equivalent of the dividend of $US53,000,000 declared by CPIHL(UK) on 22 March 1990. The sum of $49,726,875 was the Australian dollar equivalent of that portion of the dividend of $US100,000,000 declared by CPIL(UK) on 22 March 1990 attributed by the Commissioner to CPH.
21 An objection to the CPH assessment was disallowed on 21 December 1995. That objection decision was the subject of appeal number NG 76 of 1996. The appeal was allowed by Hill J, who made an order setting aside the decision. His Honour's judgment on that assessment is the subject of appeal NG 1172 of 1998 by the Commissioner of Taxation to this Court.
22 The Commissioner's delegate also issued a determination on 21 December 1994 in respect of MLG for the year of income ended 30 June 1990. This was in substantially the same terms as the determination for CPH, except that the tax benefit was said to be $81,748,275. This amount was the Australian dollar equivalent of that portion of the dividend of $US100,000,000 declared by CPIL(UK) attributed by the Commissioner to MLG.
23 On the same day, an assessment issued to MLG adjusting its taxable income of "Nil", as set out in its income tax return for the year ended 30 June 1990 to $94,434,357. The adjustment was based in part upon deemed dividends received from CPIL(UK). These elements of the adjustment were made pursuant to determinations by an Assistant Commissioner of Taxation that the amounts represented tax benefits which had been obtained or would, but for the operation of s 177F be obtained in connection with a scheme to which Part IVA of the Act applied. Again, the scheme relied upon what was said to be a dividend stripping scheme pursuant to s 177E.
24 The assessment so issued was the subject of objection, disallowance and appeal to Hill J by MLG. On 14 October 1998, in proceedings NG 72 of 1996, Hill J allowed the appeal and set aside the objection decision. His Honour's judgment is the subject of appeal number NG 1173 of 1998 by the Commissioner to this Court.
25 On 21 December 1994, the Commissioner also issued assessments to ACP (now CPH Property Pty Ltd) for the years ended 30 June 1989 and 30 June 1991. The assessment for the year ended 30 June 1989 added back to the previously determined taxable income a deduction of $9,882,740 for interest quarantined. This was set off by a deduction in the same amount of "Section 80G losses transferred from Consolidated Press (Finance) Ltd". The adjustment was supported by a determination that the interest sum represented a tax benefit that had been obtained or would, but for s 177F of the ITAA, be obtained in connection with a scheme to which Part IVA of the ITAA applied. Additional tax of $3,815.51 was raised in respect of the allegedly incorrect return.
26 The relevant assessment for the year ended 30 June 1991 issued as an amended assessment and, on the same basis as the 1989 return, disallowed a deduction of $24,435,073 for interest quarantined. This was offset by deductions allowed in the same amount so that the adjusted taxable income was $80,731,384, only $10,000 more than the previously adjusted taxable income.
27 These two assessments were objected to and both of the objections were disallowed. By appeals NG 68 and 66 of 1996, Hill J allowed the applications and set aside the objection decisions. These decisions by his Honour are the subject of appeals NG 1174 and 1175 of 1998 brought by the Commissioner to this Court.
Statutory Framework
28 There are two principal elements to these appeals, the first of which involves the construction of s 79D of the ITAA and, related to that, the operation of Part IVA. The second concerns the specific provisions of s 177E of the ITAA in relation to dividend stripping.
29 It is convenient first to set out the relevant provisions of Part IVA including s 177E, and then to refer to s 79D. The provisions of Part IVA set out are those in force at the relevant times.
30 Part IVA is entitled "Schemes to Reduce Income Tax". It was inserted into the ITAA in 1981. It confers upon the Commissioner, by virtue of s 177F, a discretion to cancel a tax benefit obtained by a taxpayer in connection with a scheme to which Part IVA applies.
31 The word "scheme" is defined in s 177A:
"177A(1) In this Part, unless the contrary intention appears:"scheme" means:
(a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and
(b) any scheme, plan, proposal, action, course of action or course of conduct;"
The definition is elaborated relevantly in two subsections:
"177A(3) The reference in the definition of "scheme" in subsection (1) to a scheme, plan, proposal, action, course of action or course of conduct shall be read as including a reference to a unilateral scheme, plan, proposal, action, course of action or course of conduct, as the case may be..
.
.
177A(5) A reference in this Part to a scheme or a part of a scheme being entered into or carried out by a person for a particular purpose shall be read as including a reference to the scheme or the part of the scheme being entered into or carried out by the person for 2 or more purposes of which that particular purpose is the dominant purpose."
Provisions relevant to the operation of Part IVA are contained in s 177B, but none of those is in issue for present purposes.
32 Section 177D defines the schemes to which Part IVA applies and is in the following terms:
"177D This Part applies to any scheme that has been or is entered into after 27 May 1981, and to any scheme that has been or is carried out or commenced to be carried out after that date (other than a scheme that was entered into on or before that date), whether the scheme has been or is entered into or carried out in Australia or outside Australia or partly in Australia and partly outside Australia, where -(a) a taxpayer (in this section referred to as the "relevant taxpayer") has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme; and
(b) having regard to -
(i) the manner in which the scheme was entered into or carried out;
(ii) the form and substance of the scheme;
(iii) the time at which the scheme was entered into and the length of the period during which the scheme was carried out;
(iv) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme;
(v) any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme;
(vi) any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme;
(vii) any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out; and
(viii) the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (vi),
it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for the purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme or of enabling the relevant taxpayer and another taxpayer or other taxpayers each to obtain a tax benefit in connection with the scheme (whether or not that person who entered into or carried out the scheme or any part of the scheme is the relevant taxpayer or is the other taxpayer or one of the other taxpayers)."
The concept of "tax benefit" is explained in s 177C which, in the relevant parts, provides:
"177C(1) Subject to this section, a reference in this Part to the obtaining by a taxpayer of a tax benefit in connection with a scheme shall be read as a reference to -
(a) an amount not being included in the assessable income of the taxpayer of a year of income where that amount would have been included, or might reasonably be expected to have been included, in the assessable income of the taxpayer of that year of income if the scheme had not been entered into or carried out; or
(b) a deduction being allowable to the taxpayer in relation to a year of income where the whole or a part of that deduction would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer in relation to that year of income if the scheme had not been entered into or carried out;
and, for the purposes of this Part, the amount of the tax benefit shall be taken to be -
(c) in a case to which paragraph (a) applies - the amount referred to in that paragraph; and
(d) in a case to which paragraph (b) applies - the amount of the whole of the deduction or of the part of the deduction, as the case may be, referred to in that paragraph."
Subsections (2) and (3) are not relevant for present purposes.
33 The special case of dividend stripping is covered in s 177E, which is headed "Stripping of Company Profits", and is and was at all relevant times in the following terms:
"177E(1) Where -(a) as a result of a scheme that is, in relation to a company -
(i) a scheme by way of or in the nature of dividend stripping; or
(ii) a scheme having substantially the effect of a scheme by way of or in the nature of a dividend stripping,
any property of the company is disposed of;
(b) in the opinion of the Commissioner, the disposal of that property represents, in whole or in part, a distribution (whether to a shareholder or another person) of profits of the company (whether of the accounting period in which the disposal occurred or of any earlier or later accounting period);
(c) if, immediately before the scheme was entered into, the company had paid a dividend out of profits of an amount equal to the amount determined by the Commissioner to be the amount of profits the distribution of which is, in his opinion, represented by the disposal of the property referred to in paragraph (a), an amount (in this subsection referred to as the "notional amount") would have been included, or might reasonably be expected to have been included, by reason of the payment of that dividend, in the assessable income of a taxpayer of a year of income; and
(d) the scheme has been or is entered into after 27 May 1981, whether in Australia or outside Australia,
the following provisions have effect:
(e) the scheme shall be taken to be a scheme to which this Part applies;
(f) for the purposes of section 177F, the taxpayer shall be taken to have obtained a tax benefit in connection with the scheme that is referable to the notional amount not being included in the assessable income of the taxpayer of the year of income; and
(g) the amount of that tax benefit shall be taken to be the notional amount.
177E(2) Without limiting the generality of subsection (1), a reference in that subsection to the disposal of property of a company shall be read as including a reference to -
(a) the payment of a dividend by the company;
(b) the making of a loan by the company (whether or not it is intended or likely that the loan will be repaid);
(c) a bailment of property by the company; and
(d) any transaction having the effect, directly or indirectly, of diminishing the value of any property of the company.
177E(3) In this section, "property" includes a chose in action and also includes any estate, interest, right or power, whether at law or in equity, in or over property."
The key expression "dividend stripping" is not defined.
34 The operative provision of Part IVA allowing for cancellation of tax benefits is to be found in s 177F. For present purposes it is only necessary to set out s 177F(1):
"177F(1) Where a tax benefit has been obtained, or would but for this section be obtained, by a taxpayer in connection with a scheme to which this Part applies, the Commissioner may -(a) in the case of a tax benefit that is referable to an amount not being included in the assessable income of the taxpayer of a year of income - determine that the whole or a part of that amount shall be included in the assessable income of the taxpayer of that year of income; or
(b) in the case of a tax benefit that is referable to a deduction or a part of a deduction being allowable to the taxpayer in relation to a year of income - determine that the whole or a part of the deduction or of the part of the deduction, as the case may be, shall not be allowable to the taxpayer in relation to that year of income;
and, where the Commissioner makes such a determination, he shall take such action as he considers necessary to give effect to that determination."
35 Section 79D of the ITAA was enacted in 1988 to cure a deficiency in the legislation relating to limitations on deductions which were connected with the derivation of foreign income. Prior to its enactment the general provisions of s 51(1) dealing with deduction of business expenses in relation to deductions connected to foreign source income were affected by s 51(6). In effect, s 51(6) quarantined deductions connected to the derivation of foreign source income in the year of income. As the learned trial judge explained it, there were two perceived deficiencies in s 51(6) which led to the enactment of s 79D. It quarantined only deductions under s 51(1) and not under other provisions of the ITAA. Further, it did not deal with cases where there were foreign losses. His Honour said:
"These related defects were cured by ensuring that s 79D operated to extend the quarantining to "any deductions allowed or allowable" provided that they related to the relevant class of foreign income."
The terms of s 79D relevant to the years of income ended 30 June 1989 and 1990 were as follows:
"(1) Where the amount of a class of income derived by a taxpayer in a year of income from a foreign source is exceeded by the sum of:
(a) any deductions allowed or allowable from the assessable income of the taxpayer of the year of income that relate exclusively to income of that class derived from that source; and
(b) so much of any other deductions allowed or allowable from that assessable income (other than apportionable deductions) as, in the opinion of the Commissioner, may appropriately be related to income of that class derived from that source;
the deductions to which paragraphs (a) and (b) apply shall be reduced respectively by amounts proportionate to those deductions and equal in total to the amount of the excess.
(2) In subsection (1) "class of income" and "foreign source" have the same meanings as in section 160AFD."
The definitions of "class of income" and "foreign source" in s 160AFD then appeared in subss (6) and (7) as follows:
"160AFD(6) For the purposes of this section:(a) interest income constitutes a single class of income;
(b) offshore banking income constitutes a single class of income; and
(c) all other income constitutes a single class of income.
.
.
.
160AFD(7) In this section -
"foreign source" in relation to a taxpayer, means -
(a) a business carried on by the taxpayer at or through one or more permanent establishments in a foreign country; or
(b) any other business, commercial or investment activity carried on by the taxpayer in a foreign country."
36 A new s 79D was introduced in 1991 applicable to assessments for the 1990-1991 year of income. The new s 79D reads as follows:
"(1) Where:(a) apart from this section, there are one or more foreign income deductions of a taxpayer in relation to a class of assessable foreign income in relation to a year of income; and
(b) either:
(i) the taxpayer did not derive any assessable foreign income of that class in the year of income; or
(ii) the taxpayer derived assessable foreign income of that class in the year of income and its amount is exceeded by the sum of the foreign income deductions;
then, for the purposes of this Act, those deductions are reduced respectively:
(c) where subparagraph (b)(i) applies - to nil; or
(d) where subparagraph (b)(ii) applies - by amounts proportionate to those deductions and equal in total to the amount of the excess referred to in that subparagraph."
The Sequence of the Reasoning of the Learned Primary Judge
Section 79D and Part IVA
37 The Commissioner contended before the learned trial judge that, in relation to ACP, there were two schemes to which the provisions of Part IVA of the ITAA applied. Each scheme was said to have begun with ACP's application for shares in MLG, and in the case of the CPIL(UK) scheme, to have ended with the allotment of shares in that company to MLG and, in the case of the CPIHL(UK) scheme, the allotment of shares by that company to MLG. A relevant tax benefit is said to have been obtained by ACP, being deductions in the year of income for interest payable on its loan from CPF available to be applied against its assessable income in circumstances where, but for the schemes, the interest would not have been deductible because it would have been precluded from deduction by virtue of the provisions of s 79D of the ITAA. In his reasons for judgment, his Honour erroneously referred to the claimed tax benefit on this aspect of the case as having been obtained by CPH and MLG.
38 The Commissioner's contention about the application of Part IVA of the ITAA to ACP failed before his Honour at the threshold because his Honour held that the relevant interest would not have been precluded from deduction by virtue of the provisions of s 79D. Section 79D would operate when there was "an amount" of a "class of income" derived having a foreign source. Where there was no such income there was no "amount" derived and s 79D did not operate to quarantine foreign income deductions from deductibility against Australian source income. In this case there had been no dividend income from CPIL(UK) to MLG. So it could be assumed that, absent the scheme, there would have been no foreign source income to ACP. As a result it was not necessary to consider the other arguments in relation to s 79D and Part IVA raised by the respondents. His Honour however rejected a submission by ACP that, absent the scheme, it could be assumed that any dividend income derived by ACP would have been treated as Australian source income for ordinary Australian income tax purposes and would not have been from a foreign source in the defined sense.
39 Although it was not necessary for his Honour to consider the application of Part IVA, he said that, having regard to the likelihood of an appeal, it was desirable for him to indicate his views on the balance of the argument. He did so on the assumption that he had been wrong in his construction of s 79D. His Honour took as his point of departure the requirement for a "scheme", as that expression is defined in s 177A(1) of the ITAA. On any view of the matter, that requirement was satisfied. The acquisition by ACP of redeemable preference shares in MLG and the acquisition by MLG of redeemable preference shares in CPIL(UK) was a scheme. So was the like sequence ending with the acquisition of redeemable preference shares in CPIHL(UK).
40 The second element involved the obtaining of a "tax benefit" as defined in s 177C of the ITAA. That element was satisfied by his Honour's assumption, contrary to his primary finding, that s 79D would, absent the scheme, have prevented interest payable by ACP from being classed as a deduction from its taxable income.
41 The third element was that the purpose of one or more of the people who entered the scheme was to enable a taxpayer to obtain a tax benefit in connection with the scheme. This was to be a conclusion about dominant purpose, based upon objective facts: Federal Commissioner of Taxation v Spotless Services Ltd (1996) 186 CLR 404. His Honour identified two purposes of the scheme:
1. The obtaining of a deduction under s 79D; and
2. The adoption of a structure which would not detract from tax credit relief.
The latter was not at the relevant time a "tax benefit" within the definition in s 177C. His Honour concluded, however, that the dominant purpose of the scheme's advisers in particular was to bring about the result that a deduction would be allowed to the applicants which, but for the scheme, would have been disallowed to them because of the application of s 79D. The interest deduction was more immediate than the adoption of a neutral structure for non-interference with tax credits. It follows that, but for his Honour's conclusion as to the construction of s 79D, the Commissioner would have succeeded on the Part IVA question.
Section 177E and Dividend Stripping Schemes
42 In relation to CPH and MLG, the Commissioner contended before his Honour that s 177E of Part IVA, relating to dividend stripping schemes, applied to the transfer to CPIL(B) of the shares held by each of these companies in CPIL(UK) and CPIHL(UK), the subsequent liquidation of those companies, the sequence of loans, the payment of dividends and liquidation distributions. Alternatively, if s 177E were not applicable, the ordinary provisions of Part IVA could be invoked so as to include an amount in the assessable income of MLG and CPH.
43 His Honour identified the elements necessary to attract the application of s 177E. The section required the existence of a scheme, as to which his Honour held that the steps identified by the Commissioner constituted a scheme as defined in s 177A(1). The scheme had to be by way of or in the nature of dividend stripping or to have had substantially the effect of such a scheme. It had to result in the disposal of property. The Commissioner had to be able to form the opinion under s 177E(1)(b) that relevant disposal represented in whole or part a distribution of profits of the company. The hypothesis in s 177E(1)(c) had to be satisfied, namely that if before the scheme had been entered into a dividend had been paid out of profits to the extent the Commissioner determined were treated as having been distributed, it could reasonably have been expected that amounts would have been included in the assessable income of the taxpayer in a year of income.
44 His Honour identified the essential character of a dividend stripping scheme as one involving a company pregnant with accumulated profits, out of which a dividend would reasonably be likely to be declared or which had already been declared or where the company was about to receive profits in the future out of which a dividend would reasonably be likely to be declared. It involved the setting up of that company for sale by conversion of its assets to cash or the purchase back of operating assets so that its substantial assets became cash or loans back. It involved the sale or allotment of shares in the target company to the stripper and the subsequent payment of a dividend to the stripper by the target company or a deemed dividend to recoup the stripper for the outlay of the shares. The fact that the consideration for the sale of shares was not cash but an allotment of shares did not necessarily exclude the scheme from being a scheme in the nature of dividend stripping.
45 In his Honour's view, however, an objective examination of what had taken place in this case did not lead to the conclusion that there was a dividend stripping scheme or, for that matter, a scheme in the nature of dividend stripping if that were a significantly different thing. The United Kingdom companies had substantial investments in overseas companies from which dividends could be derived. They had no need to distribute accumulated profits. The accumulated profits could have sat there for ever. The sale of shares and subsequent liquidations were not brought about to enable the shareholders to receive capital instead of dividend distributions (although that was a consequence of what happened). They occurred as part of a reorganisation of the United Kingdom companies for reasons which had to do with United Kingdom and Australian tax, rather than obtaining dividends derived from the accumulated profits.
46 His Honour then considered whether the scheme was one "having substantially the effect of a scheme by way of or in the nature of a dividend stripping", within subpar 177E(1)(a)(ii) of the ITAA. This required a focus away from the essential character and nature of the scheme to a focus on effect. In his Honour's view, the relevant "effect" was to be judged by reference to the vendor of the shares in the target company and the target company itself. The scheme in respect of CPIHL(UK) only, was capable of being seen as one having the effect of a dividend stripping scheme such as to make s 177E applicable, but subject to the other matters with which that section is concerned.
47 CPIHL(UK) had substantial accumulated profits and current year profits. (Its audited accounts at 30 June 1989 showed accumulated profits of $US86,825,000 and, in the succeeding three months, it had an operating profit after tax of $US17,557,000.) The result of the scheme, in the case of CPIHL(UK), was that the shareholders received capital for their shares in an amount which included the accumulated profits and the purchaser received a distribution in specie. The scheme was capable of having the effect of a dividend stripping scheme, such as to make s 177E applicable.
48 The position was different with respect to CPIL(UK). As at 30 June 1989, it had accumulated losses of $US69,449,000. It had derived net profits of $US65,147,000 during the period 1 July 1989 to 31 December 1989. His Honour said this of the scheme in relation to CPIL(UK):
"it is difficult having regard to the fact that it had a negative balance in its accumulated profits account, although a current year profit, to see that the effect of any scheme was one of dividend stripping. By the time the scheme was undertaken no further profits were to be earned, and the current year's profit could be offset by prior years' losses."
His Honour considered that there had been a disposal of property of the United Kingdom companies. Even if no dividends had been paid, the distributions in specie of assets in the liquidation clearly enough were disposals. Those disposals resulted from the scheme.
49 CPH and MLG had argued that the purported declarations of dividends by the United Kingdom companies were void because the articles of association of each company permitted the directors only to pay an interim dividend. This was advanced in support of an argument that no dividends had ever been paid and that, therefore, there had been no disposal of the property of the United Kingdom companies. His Honour did not think it mattered to the outcome of the appeals to reach a conclusion on the point. If the resolution were invalid then the distributions of assets were distributions by the company in liquidation. In either case, the result of the scheme in respect of CPIHL(UK) was dividend stripping. In the case of that company, there had also been a disposal resulting from the scheme.
50 Paragraph 177E(1)(b) of the ITAA requires that the Commissioner form an opinion under s 177E that the relevant disposal represented in whole or in part a distribution of profits of the target company. ACP and MLG submitted that the formation of the Commissioner's opinion was vitiated in law and for that reason, whether or not there had been a dividend stripping, the provisions of Part IVA had no operation. The Commissioner had determined that the net assets of both companies represented profits available for distribution.
51 His Honour took the view that the Commissioner had conceded that CPIL(UK) did not, on any view of the matter, have profits sufficient to support treating any disposal of assets as representing a distribution of profits. (In this Court the Commissioner contends that his Honour was in error and that no concession was in fact made.) His Honour observed that the Commissioner was only able to reach the result he did by pooling the assets of the two companies when clearly he had to consider each separately for the purposes of s 177E(1)(b). He described the Commissioner's approach as an "arbitrary course". The Commissioner had never turned his mind to the amount of profits that had existed in each company, let alone how much was represented by the relevant disposal. His Honour concluded that, for these reasons, the discretion of the Commissioner under s 177E(1)(b) had miscarried. Since Part IVA could not apply unless the Commissioner had formed the relevant opinion, the assessments, so far as they were dependent upon s 177E, had to be set aside.
52 His Honour then turned to the Commissioner's submission that if he failed to succeed under s 177E he could support the assessment under s 177D relying upon the general provisions of Part IVA. His Honour could not see how, without the aid of s 177E, it could properly be said that there was a tax benefit to the applicants as defined in s 177C. There was no inevitability about the distribution of taxable dividends in relation to the year of income in question if the sale of the shares had not been entered into.
53 The Commissioner's exercise of discretion under s 177F was dependent upon treating the transaction as one falling within s 177E. He had not applied his mind to the matters in s 177F by reference to Part IVA without the application of s 177E. His Honour accepted that this might not be fatal since Part IVA could apply without the exercise of discretion. In any event, it appears from his judgment that he disposed of this issue on the basis of the absence of any tax benefit to the applicants.
The Appeal Grounds
54 The question of the proper construction of s 79D of the ITAA arose, as noted, in relation to the assessments issued against ACP for the years of income 1988-1989 and 1990-1991 (appeals NG 1174 and 1175 of 1998). The Commissioner's grounds of appeal in each case were generally similar. It is not necessary to set them out in full but at their core was the proposition that the learned trial judge erred in holding that s 79D of the ITAA as in force in each of the 1988-1989 and 1989-1990 income years had no application where, in the year of income, no foreign source income was derived. It was also a ground that the learned trial judge erred in failing to hold that the dominant purpose of a participant in the scheme as found by him, namely to bring about the result that a deduction would be allowed to ACP which, but for the scheme, would have been disallowed because of the application of s 79D, was not a purpose of enabling ACP to obtain a tax benefit in connection with the scheme.
55 In respect of each of the appeals affecting ACP, ACP filed a notice of contention asserting that his Honour erred in deciding that:
"(a) any hypothetical dividends paid on the shares in Consolidated Press International Limited (UK) would have been "income from a foreign source" for the purpose of Section 79D of the Income Tax Assessment Act 1936 ("the Act");
(b) it was a consequence of the decision of the High Court in Federal Commissioner of Taxation v Spotless Services Limited (1996) 186 CLR 404 that the Appellant could artificially dissect part of a scheme from the totality of the scheme adopted and, in particular, in the fashion in which he did;
(c) a conclusion could be drawn that the dominant purpose of some person (not particularised as a party to that scheme) was to bring about the result that a deduction would be allowed which, but for the scheme, would have been disallowed because of the application of section 79D; and
(d) such a conclusion would be drawn."
56 In the appeal relating to the assessment issued to CPH for the year of income 1989-1990 (NG 1172 of 1998) and the assessment issued to MLG for the same year (NG 1173 of 1998), the appeal grounds focussed on the question of his Honour's findings relating to the dividend stripping scheme. The grounds of appeal attacked his Honour's failure to find schemes in relation to both CPIL(UK) and CPIHL(UK) that were schemes by way of or in the nature of dividend stripping within the meaning of s 177E(1)(a) and failing to find a scheme in relation to CPIL(UK) that was a scheme having substantially the effect of such a scheme. His Honour was said to have erred in failing to hold that the property of CPIL(UK), namely the sum of $US100 million, was disposed of as a result of the scheme that was, in relation to CPIL(UK), a scheme by way of or in the nature of dividend stripping or having substantially the effect of a scheme by way of or in the nature of dividend stripping within the meaning of s 177E(1)(a). Aspects of his Honour's reasoning leading to his conclusion in that respect were also attacked in separate grounds of appeal which it is not necessary to set out here.
57 In relation to the validity of the declarations of the dividends, it was said that his Honour erred in failing to hold that, if the declarations of dividends by the directors of CPIL(UK) were beyond power, the shareholder companies by their conduct had ratified the declarations. His Honour was also said to have erred in failing to find that the Commissioner had formed the opinion that the disposal of $US100 million of the property of CPIL(UK) represented in whole or in part a distribution of profits of the company. It was also claimed that his Honour erred in failing to hold that the Court should reach its own conclusion as to whether the Commissioner ought to have formed the opinion that the disposal of the property represented a distribution of profits of CPIL(UK). Linked to that ground is the contention that his Honour erred in failing to hold that the Commissioner ought to have been of the opinion that the disposal of $US100 million represented in whole or in part a distribution of profits of the company.
Nature of the Findings Reviewed 58 His Honour's decisions in relation to the ACP appeals turned upon the threshold proposition that s 79D would not have operated to prevent ACP's interest payments from being treated as deductions. This was a proposition of law which, applied to the facts found to that point by his Honour, negatived an essential element of the Part IVA scheme posited by the Commissioner.
59 His Honour then proceeded to consider the application of Part IVA on the assumption that he was wrong about the construction of s 79D. That consideration involved additional findings of law and fact, the meaning of the relevant provisions of Part IVA and their application to facts as found. Although his Honour foreshadowed this part of his reasoning with the words "...it is desirable that I indicate my views on the balance of the argument" his findings of fact were not hypothetical. In this respect, it should also be noted that in his finding under s 177D about the purpose of persons participating in the scheme, his Honour began with the words:
"With some doubt I am of the view that a conclusion would be drawn..."
60 The statement of doubt is not a statement that the finding is provisional or hypothetical. A finding on the balance of probabilities sufficient to establish liability in civil proceedings may nevertheless be attended by doubt. It may and, in this case was, nevertheless a definitive finding. The use of the words "that a conclusion would be drawn...." again does not reflect any disinclination on the part of his Honour to make the relevant finding. The words of s 177D(b) require a finding as to whether "it would be concluded that the person, or one of the persons, who entered into or carried out the scheme...did so for the [relevant purpose]..." His Honour's views of the law and his findings of additional facts provided a basis for the conclusion that, if his Honour were wrong on s 79D, then Part IVA did apply to the scheme in which ACP was participating. His findings of law were not obiter, nor were his findings of fact hypothetical or provisional. In disposing of the appeal so far as it relates to these issues, the Court is required to consider his Honour's findings in that light. In particular, his findings of fact had no less weight in relation to the general Part IVA issue than the findings of fact supporting his conclusions about the outcome of the s 79D aspect of the case.
The Construction of Section 79D
61 The Commissioner's submissions on the s 79D/Part IVA scheme in relation to ACP began by identifying as the issue for the 1989 year, the question whether, by reason of Part IVA, interest incurred by ACP on the loan from CPF was an allowable deduction. For the 1991 year ACP had returned, inter alia, a loss carried forward from the year ended 30 June 1990. The issue for that year of income was therefore whether by reason of Part IVA the amounts of interest incurred by ACP in the 1990 and 1991 years were allowable deductions. The Commissioner contended that in each of the 1989, 1990 and 1991 years there was a scheme within the meaning of s 177A of the ITAA, and that by virtue of the scheme a deduction in respect of the interest incurred on the loans from CPF was allowable to ACP under s 51(1) of the ITAA in circumstances where, by reason of s 79D of the ITAA, it might reasonably be expected that, had the scheme not been entered into, the deduction would not have been allowable.
62 A diagram of the relevant sequence of transactions is attached to these reasons. The scheme for which the Commissioner contended is represented by that part of the diagram comprising ACP, MLG and CPIL(UK). Central to the scheme was the interposition of MLG and the use of funds borrowed by CPF to subscribe for redeemable preference shares in MLG which in turn subscribed for shares in CPIL(UK). Absent the scheme thus described it could, on the Commissioner's view, reasonably have been expected that ACP would have subscribed directly for the shares in CPIL(UK) using loans from CPF for that purpose. In that event, it is said that s 79D would have operated to prevent interest payments by ACP to CPF from being claimed as deductions against income earned in Australia. They could only have been claimed against the class of income, derived from a foreign source, to which they related.
63 The scheme, by interposing the subscription from ACP for redeemable preference shares in MLG, sought to break the relationship between interest paid on the CPF loans and potential foreign source income by way of dividend payments on the shares from CPIL(UK). The introduction of the MLG transaction could only, however, yield a tax benefit if otherwise s 79D would have operated to quarantine the deductibility of ACP's interest payments so that such deductibility could only be asserted against the related foreign source income. Absent the interposition of MLG, ACP would not have derived assessable foreign source income in the year of income 1989/1990 from the direct acquisition of the CPIL(UK) shares. The anticipated dividend flow from those shares did not materialise because the BAT acquisition, which was to be the source of dividend income, did not proceed. The existence of a tax benefit in the year of income 1989/1990 therefore depends upon whether s 79D, as it stood, operated to "quarantine" the deductibility of outgoings related to income from a foreign source where the amount of that income was nil. This aspect of the case reduces to a question of construction.
64 Turning first to the words of s 79D as it stood in the 1989/1990 year of income, the factual situations to which it applied were required to have the following elements:
(i) an amount of a class of income derived by a taxpayer in a year of income from a foreign source;
(ii) deductions relating exclusively to income of that class derived from that source;
(iii) other deductions that, in the opinion of the Commissioner, might appropriately be related to income of that class derived from that source; and
(iv) an excess of the sum of the deductions over the amount of the class of income referred to.
65 The words "amount of a class of income derived by a taxpayer in a year of income from a foreign source" are susceptible of the construction that they refer only to a non-zero amount of income. His Honour placed reliance upon the requirement that there be an "amount derived". It was, in his view, difficult to see how these words could encompass the case where nothing at all was derived. Moreover it was hard to imagine how a zero amount could be treated as having a particular source, foreign or otherwise. It might be added that on one view it is also difficult to see how a deduction can be said to "relate...to" income of a particular class where there is no such income. But these difficulties depend upon reading the section on the assumption that it is concerned with the offset of actual income and allowable deductions.
66 On another reading, the collocation "class of income derived by a taxpayer in a year of income from a foreign source" is adjectival. It defines the category of income to which a deduction must relate if it is to be burdened by the quarantining operation of the section. It therefore identifies the class of deduction upon which the section operates. There is no requirement flowing from the internal logic of the section so read, that the amount of income be non-zero. A category of things may be defined even if it may on occasion be empty. Further, the section operates by reference to "the amount of the excess" of the related deductions over the amount of the relevant class of foreign source income. It is concerned with the difference between that income and related deductions. When regard is paid to the logical importance of that difference, the sense of the section is not offended by applying it to a case in which the amount of the relevant class of income is zero. The constructional choice which encompasses zero foreign source income is open upon a literal reading of the section. In this regard we respectfully differ from his Honour's view that this is "a construction which the literal language of s 79D does not bear".
67 Given that the latter construction is open, it is to be preferred. For a given deduction related to a class of foreign income, the less the amount of the income the greater the excess of the deduction over it. Therefore the greater will be the proportion of that deduction not able to be claimed as an allowable deduction. That is to say, the less the foreign source income for a given deduction, the greater the amount of the deduction that is quarantined. But if the section does not touch the case of zero income in the relevant class then, when the income diminishes to zero, the whole of the deduction becomes potentially allowable against non foreign source income. On the construction for which ACP contends, the case of zero foreign source income creates a singularity or discontinuity which annihilates the operation of s 79D. There is no requirement in logic nor reason in policy why this should be so.
68 His Honour found no clear answer to the constructional question in the legislative history, the extrinsic materials or the legislative context in which s 79D is to be found. Nor was there. Nonetheless, in his Honour's view, which was effectively adopted by counsel for ACP, there is nothing intrinsically absurd about quarantining a deduction against foreign income but not quarantining a deduction where no foreign income is derived. As his Honour pointed out, deductions can be incurred prior to income being derived just as they may be incurred and allowable after the income to which they are directed may have ceased.
69 There is no doubting the correctness of those propositions. They have a respectable lineage: see generally AGC (Advances) Ltd v Federal Commissioner of Taxation (1975) 132 CLR 175, at 188 per Barwick CJ. The anomaly which his Honour identified in the present case was that, upon the Commissioner's construction, a deduction would be lost in the latter case and might never be allowed in the former if it should turn out that no foreign income were ever derived. That may be accepted as a consequence of the Commissioner's construction and it appeared that the Commissioner accepted that consequence. It may be that the case contemplated by his Honour reflects a harsh consequence of the operation of the section. But it is not absurd or irrational. In our opinion, this consideration does not outweigh the considerations of logic and policy which militate in favour of the application of s 79D to the case of zero income in the relevant class from a foreign source.
70 It was submitted in the alternative for ACP that, even if the Commissioner's construction of s 79D were correct, it could not operate in the present case in either of the 1989 or 1991 years of income because the only income that could be derived by ACP to which the relevant interest deductions might relate would be dividends paid on the shares in CPIL(UK). But these dividends, it was submitted, would not have a foreign source within the meaning of that term as defined in s 160AFD. In support of this proposition it was said that:
(i) ACP's hypothetical subscription for and holding of shares in CPIL(UK) did not constitute, and would not have constituted, it carrying on business at or through one or more permanent establishments in a foreign country as required in par (a) of the definition of "foreign source".
(ii) ACP's hypothetical subscription for and holding of shares in CPIL(UK) did not constitute, and would not have constituted, any other business, commercial or investment activity "carried on" in a foreign country as required by par (b) of the definition of "foreign source".
Under the assumption the Commissioner asked the Court to make, ACP's business, commercial and investment activity, so far as it concerned its investment in shares in CPIL(UK), was carried on in Australia where its central management and control was located. That is where the subscription for the shares would have taken place. Reliance was placed upon Esquire Nominees Ltd v Federal Commissioner of Taxation (1973) 129 CLR 177 and Thiel v Federal Commissioner of Taxation (1990) 171 CLR 338. This proposition had been put to and rejected by his Honour.
71 Esquire Nominees concerned an assessment for dividend income received by Esquire Nominees Ltd, which was a resident of the territory of Norfolk Island. The ITAA in s 7 provided that the Act extended to Norfolk Island and other territories but did not "apply to any income derived by a resident of those Territories from sources within those Territories". The dividend issued was paid by another company incorporated in Norfolk Island and came from funds derived from a dividend paid to it by an Australian company, that payment originating in turn from dividends from another Australian company carrying on business in Australia. The Court held that the source of the dividend derived by Esquire Nominees Ltd was within Norfolk Island. Barwick CJ held (at 212) the fund of profits of the company paying the dividend to be the source of that dividend. This extended to dividends derived from profits earned from investment income. He also said at 212:
"Further, in my opinion, the place where the company makes its investment income will be the place where it has its central management and control. It will, of course, be different in the case of a company conducting manufacturing or trading activities. In the case of such companies the place where these activities are carried on can be seen in fact to be the geographical source of the profits these activities yield."
Menzies J at 221 and 222 and Stephen J at 229 also, in effect, held the source of dividend income to be the place where the profit (out of which the income was paid) was made. Esquire Nominees therefore is against ACP's submissions in so far as it identifies the geographical source of dividend income as the location of the funds from which the dividend is paid.
72 It must be recognised, in any event, that Esquire Nominees raised a different issue in a statutory context different from that applicable in this case. There the issue raised by s 7 of the ITAA was whether the income derived by the taxpayer was from "sources within" the territory of Norfolk Island. In this case, the question is whether the income to the taxpayer would have derived from a foreign source in the sense of a business, commercial or investment activity carried on by it in a foreign country. The identification of source is less concerned with the location of the fund than the location of the business, commercial or investment activity which generated the receipt of the relevant income, or which, in this case, would have generated the receipt of the relevant income.
73 Here the relevant investment activity, namely acquisition of the CPIL(UK) shares, was carried on in the United Kingdom. It was not an investment activity carried on within Australia. The source of the dividend was therefore a foreign source at least within the meaning of par (b) of the definition of that term in s 160AFD(7). It can also be accepted, as his Honour accepted, that the carrying on of the relevant activity referred to in the definition of "foreign source" does not require a repetition of transactions. In the context of the Double Taxation Agreement between Australia and Switzerland, the High Court held in Thiel that the expression "enterprise carried on by" in Article 3(1)(f) of the Treaty did not require a repetition of activity. It would extend to an isolated activity and a framework for making and carrying out decisions in relation to activities and projects. We respectfully adopt his Honour's observation when, after referring to Thiel, he said (at 23):
"The context in s 79D is whether an Australian resident derives income from an investment activity which is carried on in a foreign country. It would seem highly unlikely that the legislature intended to quarantine deductions against foreign income where there was no repetition of the activity but not do so where the activity was done once and once only. In my view s 79D should be construed, consistent with the general law of source in any case, to bring about the result that a dividend from an overseas company in which the taxpayer has invested is to be treated as having a foreign source for the purposes of the section."
74 For the preceding reasons, the Commissioner's case on the construction of s 79D succeeds and ACP's case on that section fails. Section 79D would have applied to interest paid by ACP to CPH had MLG not been interposed in the chain of transactions leading to the acquisition of the CPIL(UK) shares. It is necessary, therefore, to consider whether Part IVA applied to support the Commissioner's determination that the deductibility of the interest was a tax benefit obtained in connection with a scheme under that Part.
Part IVA - The Scheme - Section 177A
75 Part IVA operates upon "schemes". "Scheme" is defined generally in s 177A. The subclass to which Part IVA applies is defined in s 177D. Where a tax benefit, as defined in s 177C, has been or would, but for s 177F, be obtained, by a taxpayer in connection with a scheme, the Commissioner may make a determination that the benefit shall be included in the taxpayer's assessable income: s 177F. If the benefit is referable to a deduction then the Commissioner may determine that the deduction shall not be allowable.
76 In this case, the "scheme" identified by the Commissioner in relation to ACP was "the acquisition by ACP of redeemable preference shares in MLG and the acquisition by MLG of redeemable preference shares in CPIL(UK) in one case and CPIHL(UK) in the other". The scheme so identified was attacked by ACP as "an artificial dissection of part of a scheme by the Commissioner" and said not to be permissible. The decisions of the High Court in Federal Commissioner of Taxation v Peabody (1994) 181 CLR 359 and Spotless were said to preclude such a dissection.
77 The decision in Peabody is authority for the proposition that the Commissioner's discretion to cancel a tax benefit under Part IVA extends only to a tax benefit which is or would be obtained in connection with a scheme to which that Part applies. The exercise of the discretion does not depend upon its correct identification by the Commissioner. If there is a scheme to which Part IVA applies and there has been or would be a tax benefit obtained in connection with it, the Commissioner's discretion is enlivened. In particularising his case in appeal proceedings, the Commissioner may identify one scheme and alternatively rely upon another which is a sub-set of the first (at 382).
78 On the other hand as the Court observed in the joint judgment in that case (at 383-384):
"But Part IVA does not provide that a scheme includes part of a scheme and it is possible, despite the very wide definition of a scheme, to conceive of a set of circumstances which constitutes only part of a scheme and not a scheme in itself. That will occur where the circumstances are incapable of standing on their own without being "robbed of all practical meaning". In that event, it is not possible in our view to say that those circumstances constitute a scheme rather than part of a scheme merely because of the provision made by ss 177D and 177A. The fact that the relevant purpose under s 177D may be the purpose or dominant purpose under s 177A(5) of a person who carries out only part of the scheme is insufficient to enable part of a scheme to be regarded as a scheme on its own. That, of course, does not mean that if part of a scheme may be identified as a scheme in itself the Commissioner is precluded from relying upon it as well as the wider scheme."
79 ACP argued that the borrowing of $300,600,000 from CPF on 2 May 1989 was not treated by the Commissioner as part of the scheme for the purposes of Part IVA. Nor was the loan by CPIL(UK) to CPI(Sing) which was relevant to the BAT takeover. The overriding purpose of the whole scheme was to put CPI(Sing) in sufficient funds to participate in Hoylake and its bid for the control of BAT which was expected to yield profits in the vicinity of one billion pounds. This was said to be a wholly commercial purpose and his Honour had so found. The scheme identified artificially excluded the loan from CPF to ACP, the loan from CPIL(UK) to CPI(Sing) and CPI(Sing)'s investment in Hoylake. These exclusions were said to have "robbed [the scheme] of all practical meaning". The latter term, used in the passage quoted from Peabody, was taken from the judgment of Lord Pearce in Inland Revenue Commissioners v Brebner [1967] 2 AC 18 at 27. That case concerned a general tax avoidance provision in s 28 of the Finance Act 1960 (UK). The section operated upon transactions whose effect singularly or in combinations of two or more provided a tax advantage. The House of Lords held that the Special Commissioners were justified in concluding that certain transactions were entered into for bona fide commercial purposes. Lord Pearce said, at p 27:
"But that which had to be ascertained was the object (not the effect) of each interrelated transaction in its actual context and not the isolated object of each part regardless of the others. The subsection would be robbed of all practical meaning if one had to isolate one part of the carrying out of the arrangement, namely, the actual resolutions which resulted in the tax advantage, and divorce it from the object of the whole arrangement. The method of carrying it out was intended as one part of a whole which was dominated by other considerations."
80 All that having been said, a scheme identified as such may, as was pointed out in Peabody, be a scheme for the purposes of Part IVA even if it can also be regarded as part of a larger scheme. The first resort in determining whether what the Commissioner and his Honour identified as a "scheme" properly answered that description must be the words of the definition in s 177A. The caveat in Peabody sets a broadly stated outer limit upon those words. It is evaluative in character. Whether circumstances "standing on their own" are "robbed of all practical meaning" is a matter of judgment rather than logical analysis. Under the definition in par 177A(1)(b) a scheme encompasses any "action, course of action or course of conduct". It may be "unilateral" (s 177A(3)). On the other hand the action, course of action or course of conduct which may constitute a scheme may involve action or conduct by more than one person.
81 In this case the actions identified by the Commissioner and accepted by his Honour as constituting a scheme did fall within the definition in s 177A(1)(b). They can be described in the precise way his Honour described them "...the acquisition by ACP of redeemable preference shares in MLG and the acquisition by MLG of redeemable preference shares in CPIL(UK)". They can also be described compendiously as the interposition of MLG between ACP and CPIL(UK). They can be regarded as a module or component of the larger set of transactions. That does not prevent them from being treated as a scheme. The two transactions have a practical meaning. They are in a sense self explanatory. The identification of their purpose which may have to be undertaken in the context of surrounding transactions is not a condition of their characterisation as a scheme. The identification of a scheme within the meaning of s 177A is antecedent to its characterisation as a scheme to which Part IVA applies as defined in s 177D. It would be an error to suppose that identification of purpose is necessary in determining whether there is in existence a scheme under s 177A.
Part IVA - The Tax Benefit - Par 177D(a) and Section 177C
82 The scheme having been identified correctly by his Honour, the next question was whether it was one to which Part IVA applied within the meaning of s 177D. The first relevant condition of that characterisation, imposed by par 177D(a), is that a taxpayer has obtained, or would but for s 177F obtain, a tax benefit in connection with the scheme.
83 Section 177C(1) explains what is meant by the reference in par 177D(a) to "the obtaining ... of a tax benefit in connection with a scheme". The relevant circumstance is set out in par (b) of s 177C(1). That is:
"a deduction being allowable to the taxpayer in relation to a year of income where the whole or a part of that deduction would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer in relation to that year of income if the scheme had not been entered into or carried out."
His Honour in this case said that the deduction was allowable to ACP under s 79D. Strictly speaking, as counsel for the Commissioner pointed out, the deduction, if it had arisen, would have been allowable under s 51, not being disallowed by virtue of the quarantining operation of s 79D.
84 The question of reasonable expectation raised in s 177C(1) has been the subject of comment in Peabody. The observations made in that case are important to the construction of this provision but, having been made in a particular factual context, must be read in that context. It is appropriate therefore in considering the question of reasonable expectation to begin with the words of s 177C and endeavour to apply them to the facts of this case.
85 There are two hypotheses which, absent the relevant scheme, satisfy the condition for demonstration of a tax benefit in relation to a deduction. The first is that the deduction would not have been allowable. The second is that the deduction might reasonably be expected not to have been allowable. The hypotheses would encompass the respective propositions that the outgoings said to constitute the deduction would, or might reasonably be expected to, have been incurred absent the scheme. The like hypotheses under par 177C(1)(a) would have to encompass the propositions that an amount, capable of being income, would or might reasonably be expected to have been derived absent the scheme. The extension of the hypotheses to the existence of income amounts and deductions in the relevant year is not demanded by the words of pars (a) and (b) which in their ordinary meaning assume those facts. That restrictive construction however could lead to quite artificial and unfair hypotheses adverse to taxpayers being forced upon the Commissioner and the Courts. The construction which requires the hypothetical situation absent the scheme to extend to circumstances which might or might not give rise to the relevant income or deductions reflects the approach taken by the High Court in Peabody where it was said (at 385) in the joint judgment:
157 Since the legislation does not identify those central characteristics, it is necessary to look to the decided cases preceding the 1981 Act and to the extrinsic materials accompanying the relevant legislation. We have identified what we would see as the central characteristics of a dividend stripping scheme, by reference to the High Court decisions discussed in Patcorp. The six characteristics so identified are set out in pars 136 and 137. They are similar to those identified by the primary Judge as comprising the "essential character" of a dividend stripping operation.
158 The present scheme has a number of features supporting the Commissioner's contention that it can fairly be described as one by way of or in the nature of dividend stripping. The features are the following:
* prior to the commencement of the scheme the UK companies had substantial undistributed profits;
* had dividends been declared out of the available profits, the shareholders (CPH and MLG) would have incurred a substantial liability to pay Australian tax, since the dividends would have formed part of their assessable income;
* the dividends actually declared by the UK companies virtually exhausted the total profits available for distribution;
* CPH and MLG sold their shares in the UK companies to CPIL(B) cum dividend;
* CPIL(B) received a distribution of the assets of the UK companies, partly in purported satisfaction of the dividend;
* CPIL(B), as a Bermudan resident, was not liable to Australian tax in respect of the distribution; and
* CPH and MLG were allotted shares in CPIL(B) which, in part, were referable to the dividend component of the sale of their shares in CPIL(B).
159 On the other hand, CPH and MLG identified features of the scheme that were said not to satisfy the first limb of s 177E(1)(a). Some of the features so identified are, in our opinion, compatible with the existence of a scheme by way of or in the nature of dividend stripping:
* The fact that the "stripper" (CPIL(B)) was not a dealer in shares is not critical to the existence of a dividend stripping operation. In Bell, the shares in the target company were acquired by private individuals who were not dealers. The critical point is that the dividends paid to those who acquired the shares were not assessable income for Australian tax purposes.
* Nor is the fact that the stripper in this case was a member of the same corporate group inconsistent with a dividend stripping operation. In Ellers Motors, a dividend stripping case, the profits remained within the "company cell": see at 623.
* The fact that CPH and MLG each received an allotment of shares, rather than cash, as the consideration for their shares in the UK companies, is compatible with a dividend stripping scheme. While the vendor shareholders usually receive a cash payment for their shares in the target company, the fact that the consideration takes a different form is not a significant departure from the paradigm. The critical point is that the vendor shareholders receive a consideration which is in a tax-free or largely tax-free form.
* Similarly, we would regard the fact that the stripper's acquisition of the vendors' shares in the target company is not directly financed by the target company as compatible with a dividend stripping operation within the first limb, especially where the scheme involves intra-group companies: cf the example given by Fullagar J in Federal Commissioner of Taxation v Newton (1957) 96 CLR 577, at 657. Other means can readily be employed to achieve the desired result, including the issue of shares by the stripper to the vendor shareholders.
* Nor do we not think it appropriate to approach the application of the first limb of s 177E(1)(a) on the assumption (contrary to the fact) that CPIL(B) was an Australian resident. The fact is that it was a resident of Bermuda and received the distribution from the UK companies without incurring a liability to pay Australian tax on the distributions so received.
160 There are, however, two features of the scheme in the present case which are not easy to reconcile with the central characteristics of a dividend stripping scheme.
161 The first is that the assets of the UK companies did not consist wholly or even primarily of accumulated or current year profits. While CPIHL(UK) and CPIL(UK) had substantial profits available for distribution (but not required to be distributed), they each had other assets. In the case of CPIHL(UK), these amounted to at least $US186 million and in CPIL(UK)'s case to at least $US550 million. These assets were assigned to CPIL(B) as part of the reorganisation designed to avoid the risk of double taxation. The existence of these assets, particularly in the context of a corporate reorganisation, is important in relation to the question of purpose which we consider shortly. Independently of purpose, however, the fact that the target company has very substantial assets other than profits acquired by the purchaser, suggests that the scheme might not readily be described as or by way of a scheme in the nature of dividend stripping.
162 The objective feature perhaps most strongly suggesting that the scheme in this case was outside the first limb of s 177E(1)(a) is that the consideration received by each of the taxpayers for the sale of its shares in the UK companies (that is, an allotment of shares in CPIL(B)) attracted capital gains tax in Australia. As has been seen, CPH included a net assessable capital gain of $11.5 million in its return for the 1990 year, while MLG returned a gain of about $40 million. The "classic" dividend stripping operation was of course developed in Australia prior to the introduction of capital gains tax in 1985. As the Explanatory Memorandum accompanying the 1981 Bill shows, a dividend stripping operation was thought to have the effect of placing "company profits in the hands of shareholders in a tax-free form".
163 Rather surprisingly, we were not taken to the manner in which the capital gains flowing from the sale of the taxpayers' shares in the UK companies had been calculated. Nor did the parties explain how (if at all) the capital gains related to the consideration received by the taxpayers for the assignment of their entitlement to the dividends declared by the UK companies. Since s 177E has survived the introduction of the capital gains tax regime, it may be that the receipt by the vendor shareholders of a relatively small assessable capital gain (in comparison with the available profits of the target company) is compatible with the application of the first limb of s 177E(1)(a). Nonetheless, the fact that the vendor shareholders in this case reported a significant assessable capital gain by reason of the sale of their shares tends to suggest that the scheme may not fall within the first limb of s 177E(1)(a).
164 Because of the view we take on the question of purpose, it is not necessary to consider whether the departures from the paradigm of a dividend stripping operation, independently of the question of purpose, would prevent the present scheme from falling within the first limb of s 177E(a). The matters to which we have referred are, however, important in relation to the question of purpose, to which we now turn.
Is a Tax Avoidance Purpose Necessary?
165 The language of the first limb of s 177E(1)(a), while in one sense broad, is striking for the absence of any reference to a tax avoidance purpose. It simply does not address the question of whether such a purpose is required for the limb to apply and, if so, what circumstances will demonstrate that the requisite purpose is present.
166 Mr Shaw, on behalf of the Commissioner, contended that the absence of any such reference is significant, particularly when set alongside the general provisions of Part IVA. He pointed out that s 177D limits the schemes to which Part IVA generally applies to those of which, it can be concluded, by reference to specified criteria, that the person or persons entering the scheme did so for the purpose of enabling the "relevant taxpayer to obtain a tax benefit in connection with the scheme". By contrast, a scheme satisfying the four requirements specified in s 177E(1), is taken to be a scheme to which Part IVA applies: s 177E(1)(e). He argued that the concept of a dominant tax avoidance purpose should not be introduced into s 177E by the "back door method" of implying it as an essential ingredient of the expression "dividend stripping".
167 In our view, the absence of any reference to purpose in s 177E(1) is equivocal on the question of whether the first limb can only be satisfied if a tax avoidance purpose is present. The language of s 177E(1)(a), if read in isolation, is consistent with the need for such a purpose. The very concept of a "scheme" implies concerted action to achieve a particular goal. The compound concept of a "dividend stripping scheme" suggests that the predominant goal sought by the participants is a taxation benefit of a particular kind. It follows that the omission of any express reference to purpose is consistent with the drafter intending that a scheme should not fall within the first limb unless a tax avoidance purpose is present.
168 When the concept of a "dividend stripping" scheme or arrangement was introduced into the ITAA in 1972, it was on the basis, expressed in the Explanatory Memorandum, that the concept had a widely understood connotation. This was also the basis for the use of the expression "scheme by way of or in the nature of dividend stripping" in s 177E(1)(a). There is no other explanation for Parliament's disinclination to define or clarify the expression.
169 The widely understood connotation was explained in the pre-1981 case law to which we have referred. The so-called dividend stripping cases invariably had as their dominant, if not exclusive, purpose the avoidance of tax that otherwise would or might be payable by the vendor shareholders in respect of the profits of the target companies. The apparent exceptions, such as Slutzkin, are readily explicable on the basis that the particular scheme, insofar as it involved vendor shareholders, was complete before the dividend stripper began its operations and thus could not itself be described as a dividend stripping operation. The case law preceding the 1981 Act strongly supports the view that Parliament framed s 177E(1)(a) on the basis that dividend stripping operations necessarily involve a predominant tax avoidance purpose.
170 This conclusion is reinforced by the extrinsic materials to which we have also referred. The Explanatory Memorandum and second reading speech accompanying the 1981 Bill emphasised that Part IVA, which includes s 177E, was concerned with "tax avoidance arrangements that ... are blatant, artificial or contrived". According to the Explanatory Memorandum, Part IVA was not designed to catch arrangements of a normal business or family kind. Section 177E itself was to be a "self-contained code, within the framework of Part IVA" and was to deal with "dividend-stripping schemes of tax avoidance and certain variations on such schemes".
171 These carefully formulated observations, in our opinion, clearly indicate that s 177E was intended to apply only to schemes which can be said to have the dominant purpose of tax avoidance. The section was not intended, in our view, to apply to a "scheme" entered into or carried out primarily for business or other purposes unconnected with avoidance of tax, even if the scheme is implemented in a manner that produces taxation advantages: Spotless, at 425, per McHugh J. (We recognise, of course, that a taxpayer may have the dominant purpose of avoiding tax consistently with the pursuit of commercial gain in the course of carrying on a business: Spotless, at 415.) Since the section is directed at vendor shareholders participating in or benefiting from dividend stripping schemes, the required tax avoidance purpose is ordinarily that of enabling the vendor shareholders to receive profits of the target company in a substantially (if not entirely) tax-free form, thereby avoiding tax that would or might be payable if the target company's profits were distributed to shareholders by way of dividends.
172 We accept that the concept of a tax avoidance "purpose" is itself ambiguous. Depending on the statutory context, it can refer to the subjective intentions of particular persons. This was held to be the case, for example, with s 80B(5)(c) of the ITAA, which referred to an arrangement being entered into "for the purpose, or for purposes that included the purpose of enabling the company to take into account" certain losses: K Porter & Co Pty Ltd v Federal Commissioner of Taxation (1977) 19 ALR 510, at 517, per Stephen and Murphy JJ; Federal Commissioner of Taxation v Students World (Australia) Pty Ltd (1978) 138 CLR 251, at 266-267, per Mason J.
173 Section 177D of the ITAA, on the other hand, in terms posits an objective test. The question posed by that provision is whether, having regard to the eight objective factors specified in s 177D(b), a reasonable person would conclude that the taxpayers entered into or carried out the scheme for the dominant purpose of enabling the taxpayers to obtain a tax benefit in connection with the scheme: Spotless, at 422. The expression "dominant purpose" (which is the sense in which "purpose" is used in s 177D(b): see s 177A(5)) means "the ruling, prevailing, or most influential purpose": Spotless, at 416.
174 In our view, the first limb of s 177E(1) embraces only a scheme which can be said objectively to have the dominant (although not necessarily the exclusive) purpose of avoiding tax. The requirement of a tax avoidance purpose flows from the use by Parliament of the undefined expression "a scheme by way of or in the nature of dividend stripping". What is important is the nature of the scheme, not the subjective motives or intentions of any of the participants or the beneficiaries. The purpose of the scheme is to be assessed from the perspective of the reasonable observer, having regard to the characteristics of the scheme and the objective circumstances in which the scheme was designed and operated.
Was the Requisite Purpose Present?
175 The primary judge applied the appropriate test to determine whether the scheme in the present case had the necessary tax avoidance purpose. His Honour found that the sale of shares in the UK companies and the subsequent liquidations took place not for the purpose of enabling CPH and MLG to receive distributions of capital in lieu of dividends, but for the commercial purpose of reorganising the UK companies to eliminate the risk of double taxation in the light of foreshadowed legislative changes in the UK and Australia. His Honour acknowledged that one consequence of the scheme was that the capital distribution to shareholders in part represented accumulated profits that otherwise could have been distributed only as dividends, which would have formed assessable income in the hands of CPH and MLG. But an objective examination of the circumstances did not lead to the conclusion that the dominant purpose of the scheme was tax avoidance in a relevant sense. In particular, it could not be said that the dominant purpose of the scheme was to enable the vendor shareholders to avoid paying tax on dividends out of the target company's profits.
176 In our view, his Honour was correct in making these findings. The transactions of which the scheme was an integral part were entered into against a background of imminent threat of double taxation arising from the foreshadowed legislation in the UK and Australia. The scheme included steps, notably the acquisition by CPIL(B) of the issued shares in the UK companies, the winding up of those companies and the distribution of all their assets (not merely assets in satisfaction of the declared dividends), that were referable to the implementation of the corporate reorganisation designed to avoid the threat of double taxation. The documentation attending the scheme was consistent with the object of restructuring the group so as to overcome the threat of double taxation, while still maintaining a future stream of dividends to the Australian controllers. Had the scheme not been entered into, the UK companies would have been exposed to double taxation in respect of future earnings. By contrast, as the primary judge pointed out, the UK companies were under no immediate obligation to distribute their accumulated profits.
177 The scheme involved the distribution of assets of far greater value than the accumulated and current year profits of the UK companies. As we have observed, this fact suggests that the scheme is not one by way of or in the nature of dividend stripping. In the circumstances of this case, it reinforces the conclusion that the dominant purpose of the scheme was to avoid threatened double taxation, rather than to convert the taxpayer's entitlement to dividends into receipt of a capital sum. This conclusion is also reinforced by the fact that the taxpayer received assessable capital gains as the consideration for the transfer of the shares in the UK companies.
178 For these reasons, the scheme was not by way of or in the nature of dividend stripping and therefore was not within the first limb of s 177E(1)(a) of the ITAA.
A Scheme Having Substantially the Effect of a Scheme by way of or in the Nature of Dividend Stripping?
179 The primary Judge held that the scheme, insofar as it concerned the shareholders of CPIHL(UK) had "substantially the effect of a scheme by way of or in the nature of dividend stripping". It was therefore within the second limb of s 177E(1)(a).
180 His Honour's reasoning proceeded on the basis that there was a difference between the purpose and effect of a scheme. The effect was to be judged by reference to the vendor of the shares in the target company and the target company itself. With respect, the difficulty with this approach is that it leaves no work for the first limb of s 177E(1)(a) to do. If purpose is not an element in assessing the "effect" of a scheme, there would never be a case within the first limb of s 177E(1)(a), which was not also within the second limb. In any given case it would be necessary only to consider the effect of the particular scheme.
181 In our view, the drafter had something rather different in mind. It will be recalled that the Explanatory Memorandum addressed the distinction between the first and second limbs of s 177E(1)(a) (see par 152). The examples given of schemes within the first limb were those in which a dividend or a deemed dividend are paid by the target company. (Section 47(1) of the ITAA provides that distributions to shareholders by a liquidator, to the extent to which they represent income, other than income applied to replace paid-up capital, are deemed to be dividends paid to the shareholders out of the company's profits.) The example given of schemes within the second limb was one in which the profits of the target are not stripped from it "by a formal dividend payment" but by way of transactions having the effect of dividends. The particular illustrations provided were the making of irrecoverable loans to associates of the stripper or the use of accumulated profits to purchase near worthless assets, presumably at an overvalue.
182 Having regard to the Explanatory Memorandum,it can be seen that the second limb of s 177E(1)(a) is intended to catch schemes by way of or in the nature of dividend stripping, where the distribution by the target company takes a form other than a formal dividend or a deemed dividend. The reference to "having substantially the effect of" a dividend stripping scheme is to a scheme that would be within the first limb, except for the fact that the distribution by the target company is not by way of a dividend or deemed dividend. If the distribution has substantially the effect of a dividend or deemed dividend, it will be within the second limb.
183 It is true that the second limb identifies a wider range of schemes that will be caught by s 177E. But a scheme is not defined by its content alone. The word, in its ordinary meaning and its statutory definition still connotes purpose, a purpose not to be defined merely by effect. The policy underlying Part IVA, which is to attack blatant, artificial or contrived arrangements, the imposition of significant statutory penalties by way of double taxation and the intention to save normal commercial transactions, converge to support a purposive construction of the conduct covered by sub-par (ii).
184 It follows that a scheme is not within the second limb unless the dominant purpose of the scheme is that of tax avoidance in the sense explained earlier. It follows that the scheme in the present case was not within the second limb of s 177E(1)(a).
185 In the light of the conclusion we have reached, there is no need to address other issues raised by the taxpayer's submissions, namely whether there was a disposal of property for the purposes of s 177E and whether the Commissioner's opinion was validly formed for the purposes of the section. The Commissioner did not press a submission made to the trial judge, namely that even if he failed under s 177E, the assessment based on the scheme could be supported under ss 177D and 177F. In any event, any such submission would fail because, on the findings made by the trial Judge, it could not be concluded that the scheme had the requisite purpose.
186 For the reasons we have given, the schemes impugned by the Commissioner were not entered into or carried out for the dominant purpose of the avoidance of taxation. Section 177E therefore did not apply to them. Hill J was correct to set aside the objection decision based on the application of ss 177E and 177F. The appeals by the Commissioner should be dismissed.
Conclusion on Dividend Stripping Issue
187 The appeals by the Commissioner involving the assessments issued to CPH for the year of income 1989/1990 (NG 1172 of 1998) and to MLG for the same year (NG 1173 of 1998) must be dismissed. The appropriate orders in relation to each of these appeals is:
1. The appeal is dismissed.
2. The appellant is to pay the respondents' costs of the appeal.
SUMMARY OF JUDGMENTS
This summary is intended to outline the principal issues and outcomes in the judgments which are published today. It does not form part of the Reasons for Judgment.
1 The two judgments which are published today concern the amounts of income tax payable by three companies which are Australian-based members of the Consolidated Press Group. The period for which their income tax liabilities are in dispute covers the four income years from 1 July 1988 to 30 June 1992.
2 The twelve appeals in this case were brought by the Commissioner of Taxation. He had issued assessments in various years to the three Australian companies. They objected to the assessments. The Commissioner disallowed their objections and the companies then appealed to this Court. Justice Hill set aside the Commissioner's decisions disallowing the objections to the assessments and remitted the matters to the Commissioner to be dealt with in accordance with his Honour's reasons.
3 Of the twelve appeals which the Commissioner has brought in this Court against his Honour's decisions he has succeeded in two concerning the application of the tax avoidance provisions of Part IVA of the Income Tax Assessment Act to one of the Australian companies, CPH Property Pty Ltd, formerly Australian Consolidated Press Pty Ltd. The ten remaining appeals by the Commissioner concern an alleged dividend stripping scheme involving Consolidated Press Holdings Ltd and Murray Leisure Group Pty Ltd and a debt defeasance transaction connected with the issue of bonds by one of the Group's overseas members. They have been dismissed. Eight cross-appeals by Consolidated Press Holdings and Murray Leisure Group relating to one aspect of their assessments have also been dismissed. The issue on which they cross-appealed, unsuccessfully, involved the application of so called thin capitalisation rules to one of their associate companies in the Bahamas.
4 The two appeals on which the Commissioner succeeded concern the financing of a failed takeover bid in 1989 by the Consolidated Press Group for a United Kingdom company, BAT Industries Plc. The Court has held that the financing arrangements were structured in such a way as to constitute a tax avoidance scheme for the purposes of Part IVA of the Act. The beneficiary of the scheme was Australian Consolidated Press, now known as CPH Property Pty Ltd. Our disagreement with his Honour's view was confined to the interpretation of one section of the Act (s 79D). Since that section has now been amended the same issue will not arise again.
5 An alleged dividend stripping scheme was the subject of the next two appeals brought by the Commissioner. Dividend stripping schemes are a form of tax avoidance scheme for which the Act makes particular provision in s 177E. There is no precise legal definition of such schemes. Generally speaking they involve a company which has accumulated profits. The shares in the company are purchased by a third party, the stripper. The stripper, who acquires a controlling interest, declares a dividend on the shares so converting the accumulated profits into dividends. This causes the value of the shares to drop so they can be sold at a lesser price. The selling shareholders get capital in their hands and the stripper usually gets a rebate on dividends and a tax "loss" on the difference between what it paid for the shares and what it sold them for.
6 The two appeals in question involved an alleged dividend stripping scheme connected with the replacement of the Consolidated Press Group's UK holding companies by similarly named companies incorporated in the Bahamas in 1990. Justice Hill decided that the transactions associated with the liquidation of the UK companies were brought about as part of a reorganisation of the Group which had to do with proposed changes to UK and Australian tax laws. The purpose of the transactions and the associated reorganisation was to avoid exposing members of the Consolidated Press Group to double taxation in the United Kingdom and in Australia. They were not brought about for the purpose of enabling Consolidated Press Holdings and Murray Leisure Group to receive capital instead of taxable dividend distributions even though they had that result. Hill J therefore concluded that there was no scheme "by way of or in the nature of a dividend stripping".
7 There is, however, another limb to s 177E which catches "a scheme having substantially the effect of a scheme by way of ...dividend stripping". Hill J thought that some of the arrangements came within this limb. In the end, this did not matter because he found that the Commissioner had been wrong in deciding that there had been a distribution of profits of the relevant UK company. So he decided in favour of Consolidated Press Holdings and Murray Leisure Group.
8 On the appeal, the Court has decided that, because the arrangements were not entered into for the purpose of avoiding Australian tax, they could not be regarded as dividend stripping and did not come within either limb of s 177E. In other words, the arrangements did not even have the effect of a scheme by way of dividend stripping. In this respect, the Court has disagreed with Justice Hill's reasons. But the Court has reached the same result and so the Commissioner's appeals on the dividend stripping issue have been dismissed.
9 Then there were eight appeals brought by the Commissioner in respect of income said to have been earned by an overseas member of the Consolidated Press Group. This income was connected with the raising of funds by issue of bonds in Swiss francs in 1984 and 1985 and the assumption of liabilities under the bonds by a third party in 1989. This assumption of liability arrangement was called a debt defeasance agreement. The Commissioner argued that the Consolidated Press company which had effectively disposed of its liability under the bonds had made a gain from that transaction which amounted to income. He contended that the income should be attributed to the two Australian members of the Consolidated Press Group, Consolidated Press Holdings and Murray Leisure Group. We agreed with his Honour's conclusion that the alleged gain was not income of the kind which could be attributed to those companies under the Act. These eight appeals by the Commissioner were dismissed.
10 The same companies cross-appealed against his Honour's decision in respect of the same assessments but on another issue. They were liable to pay tax on income earned by one of the Consolidated Press Group based in the Bahamas. They wanted to offset, against the income earned by that company, interest payments which it made to other companies in respect of borrowings. His Honour held, however, that for certain purposes the Bahamas company had to be treated as if it were an Australian company largely funded by an overseas corporation. This meant that so called thin capitalisation rules under the Act applied and the interest payments were not deductible against that company's income except to a very limited extent. So that company's income had to be brought to account as taxable income of the Australian companies without the claimed deduction for interest. We agreed with his Honour's reasoning and dismissed the eight cross-appeals.
Alleged 79D/Part IVA Transaction
Relevant Group Companies
CPH CPF PBL
loans at
CPH PROPERTY
interest
Shares
Subscription for RPS
MLG
Subscription for shares 2,400,000 ord Australian Residents
1,000,000 RPS
Foreign Residents
I certify that the preceding one hundred and eighty-seven (187) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justices French, Sackville and Sundberg.
Associate:
Dated: 7 September 1999
DATE OF HEARING: 10-12 May 1999
DATE OF DECISION: 7 September 1999
PLACE: SYDNEY
#DATE 07:09:1999
Appearances
Counsel for the Appellant: Mr B. Shaw QC, Mr G.T. Pagone QC, Mr G. Davies QC
and Mr M. Moshinsky
Solicitor for the Appellant: Australian Government Solicitor
Counsel for the Respondents: Mr D.H. Bloom QC, Mr R. Edmonds SC and
Mr A.J. Payne
Solicitor for the Respondents: Gilbert & Tobin
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