Macquarie Finance Ltd v Commissioner of Taxation

[2006] HCATrans 43

[2006] HCATrans 043

IN THE HIGH COURT OF AUSTRALIA

Office of the Registry
  Sydney  No S499 of 2005

B e t w e e n -

MACQUARIE FINANCE LIMITED

Applicant

and

COMMISSIONER OF TAXATION

Respondent

Application for special leave to appeal

GLEESON CJ
HEYDON J

TRANSCRIPT OF PROCEEDINGS

AT SYDNEY ON FRIDAY, 10 FEBRUARY 2006, AT 11.17 AM

Copyright in the High Court of Australia

MR T.F. BATHURST, QC:   If the Court pleases, I appear with my learned friends, MR A.H. SLATER, QC and MR A.J. PAYNE, for the applicant.  (instructed by Clayton Utz)

MR G.T. PAGONE, QC:   If the Court pleases, I appear with my learned friends, MR S.J. McMILLAN and MR J.H. MOMSEN, for the respondent.  (instructed by Australian Government Solicitor)

GLEESON CJ:   Yes, Mr Bathurst.

MR BATHURST:   In the accounting period in question the applicant paid $27.9 million odd interest to noteholders on the notes issued by it and earned $28.433 million on lending of that money.  It paid tax on the latter.  It was denied a deduction in respect of the interest. 

The majority of the Full Court upheld the decision of Justice Hill disallowing the deduction.  They did so because they held the expenditure was not incurred in gaining or producing income but, rather, to meet a need for the parent of the applicant to obtain what is generally described as Tier 1 capital.  The reasoning of the Full Court your Honours will find first in the judgment of Justice French at page 96 of the book, paragraph 102:

At the time that they –

that is the notes –

were entered into the likely effect of the various transaction documents was to enable MBL to meet a need to raise Tier 1 capital for its ongoing operation . . . The likely effect may, in the circumstances of this case, be translated into an objective purpose served by the transactions.  It is a purpose properly attributed to MBL.

That is the parent.  Maybe his Honour meant the subsidiary there.

That attribution is supported, not only by a consideration of the likely effects of the transactions, but also by the testimony of the relevant officers of MBL who devised the capital raising arrangements and recommended them to MBL’s board.  There is nothing to suggest that MFL’s involvement was the result of any independent consideration by that company, or its officers, of its needs or separate purposes.

Then in paragraph 103, second sentence:

The capital raised through the issue of the notes as part of the stapled securities, consistently with the transaction documents, could have been put to a variety of purposes within the Macquarie bank group.

Justice Gyles dealt with the matter as part of the majority very shortly at page 150.  His Honour put up a counterfactual, as it were, to reach his conclusion:

In my opinion, the reasoning of the primary judge would be unassailable if MBL had issued both the notes and the preference shares.  It would be an affront to reality to regard transactions having the same parties and with the same essential characteristics capable of being switched at will by MBL and ‘stapled’ together as separate transactions.

Then going over the page to paragraph 254:

On this analysis, the ‘loan’ by MFL to MLL –

that is Macquarie Leasing, the other subsidiary –

was a marginally profitable loan of capital by one wholly owned subsidiary of MBL to another.  As I noted in Spassked Pty Ltd v Commissioner of Taxation (2003) 136 FCR 441 at [128], intra group transactions are not the same for all taxation purposes as arm’s length transactions –

and his Honour refers to Franklins which does not, with respect, say that.

Further, the immediate destination of moneys received or outlaid does not necessarily equate to the object of the receipt or payment.

His Honour refers to Ure which, with respect, was an exceptional case.

Here it can be said that the object of the receipt and payment of the ‘principal’, as reflected by the stapled note and the paid up preference share, was to provide MBL with Tier 1 capital –

Your Honours will see that in reaching that conclusion the majority focused on what might be described as either the subjective purpose or the effect desired to be achieved by the parent and the advantage sought by it rather than the advantage sought by the taxpayer.  That can be contrasted with the analysis of Justice Hely, which we say, with respect, was correct, and we say his analysis is consistent with authority binding on the Full Court both in South Australian Battery Makers and in cases such as Fletcher which in the reasoning of the Full Court disregarded.  Justice Hely’s reasoning appears at page 119 of the book, paragraph 162.  After referring to Fletcher at about line 33, his Honour says that:

On the objective facts of the present case, the outgoings in question were incurred by MFL by way of consideration for the raising by MFL of $400 million from investors in the MIS which was deployed by MFL in making an intra‑group loan to Macquarie Leasing at an interest rate greater than that payable on the notes.  The outgoings in question were thus made in the course of MFL earning its assessable income –

At paragraph 165 his Honour points out:

But looking at the transaction overall does not deny the fact that the business purpose for which the obligations under the MIS were incurred from the point of view of MFL was the raising of money from investors for deployment in MFL’s business.  That MBL also benefited by being able to increase its Tier 1 capital is not to the point –

and his Honour refers to South Australian Battery Makers.

That MBL could not itself have raised and on‑lent the funds to Macquarie Leasing within APRA guidelines does not alter the purpose for which MFL incurred the outgoings which it was obliged to make.

The passage that his Honour refers to in South Australian Battery Makers is well known and, in our respectful submission, has not been criticised or qualified by any subsequent judgment in this Court ‑ ‑ ‑

GLEESON CJ:   Just before you pass from that paragraph 165, the first sentence ends with the words “for deployment in MFL’s business”.  What was MFL’s business?

MR BATHURST:    MFL’s business had been the on‑lending of money.  The evidence was that at the time of this transaction it was, although not entirely, almost dormant and one of the reasons it was chosen to be the issuer of the notes was that it was a relatively clean company.  It does not matter, in our respectful submission, that it was commencing or recommencing business.  The position would be the same as if the money had gone to a company that is actually involved in an ongoing business.

GLEESON CJ:   Thank you.

MR BATHURST:   I will give your Honour a reference in a moment – Justice Hill makes a reference to what I have said and I will give your Honour the reference.  South Australian Battery Makers was in the bundle of material that the respondent sent to the Court.  The judgment is behind tab 2.  The relevant passages are firstly the passage from the judgment of the Chief Justice, with whom on this point Justices Stephen and Aickin agreed.  At page 655, reading from the second line after the quote from the first paragraph on that page:

The real problem in the case is not to determine the character of the advantage sought, once it has been identified, but to decide what was the advantage sought by the taxpayer by making the payments.  If the only advantage sought was the right to possession under the lease, and what was called “rent” really answered that description, clearly the outgoings were entirely of a revenue nature.  If on the other hand one advantage sought by the outgoings was the acquisition of a capital asset (the land and buildings), the fact that the payments were called ”rent”, and were made periodically, would not necessarily prevent them from being in part outgoings of a capital nature.

Then moving on to page 660, the first full paragraph about halfway down the page:

The outgoings in the present case were genuinely made in payment of rent.  The only advantage that the taxpayer sought or gained for itself by making the payments was that which it obtained as lessee under the lease.  There was nothing to suggest that the taxpayer could or would share in the advantage which Property Options would derive from the making of the payments, and the taxpayer had no legal right, or for that matter any power, to ensure that Property Options did secure its rights under the option.  The advantages gained by Property Options are therefore irrelevant in deciding upon the character of the advantage –

and the passage in Fletcher on which we rely is referred to in paragraph 14 of our submissions at page 198 of the book where the court pointed out that in circumstances where money is borrowed and outlaid to produce income and at a profit it is generally not necessary to go beyond that factor to determine whether the deduction is allowable.

Now, your Honours will recall that in South Australian Battery Makers the wider purpose of which the lease formed part was to procure the acquisition of a capital asset, namely the land and building.  This case in that respect is indistinguishable.  The wider purpose of the group may have been to obtain regulatory capital but the fact remains, looking at it from the

point of view of the taxpayer, its purpose was to outlay the funds to get a return from Macquarie Leasing.

Now, in this case the majority focused entirely on the wider arrangement and failed, as in our submission they were required to do, to consider the position of the taxpayer individually and what in fact happened to the funds.  There was, we say, no need to go to the taxpayer’s subjective thought process, much less the thought process, as it were, of the parent company.

The decision in those circumstances, with respect, is wrong.  It is important because the effect, if allowed to stand, is that entitlement to deductibility will fall to be decided, not on principles established by this Court, but on an inquiry into the subjective motivation, not only of the taxpayer, but presumably its associates and, if Justice Gyles is correct, on some, at the present time, relatively undefined group principle.  With the greatest respect, although the Federal Court has been called by this Court in many cases, save in exceptional circumstances, the ultimate court of appeal in tax matters, it is not its function to, we say, fundamentally alter the principles in this fashion, and for those matters there should be a grant of special leave.

May I just raise two matters perhaps in anticipation?  We accept that in relation to this particular transaction the debt equity rules which subsequently came into existence would have determined its outcome.  That does not affect the generality of the principle, nor does the new consolidation regime.  What the Federal Court said in this judgment may not have much effect in those circumstances.  It would certainly have an effect where the debt equity rules did not apply or where consolidation was either not available in a group or was not available.  If the Court pleases.

GLEESON CJ:   Thank you, Mr Bathurst.  Yes, Mr Pagone.

MR PAGONE:   Your Honours, our learned friend’s principal contention appears to be that the case here is indistinguishable from that of South Australian Battery Makers, and about that we say simply that there is no basis upon which the court below in any way sought to undermine South Australian Battery Makers and we also say that our learned friend is quite wrong when he says that there was the introduction into the thought process of the subjective motive or purpose or objective of the parent company or, indeed, the taxpayer.

GLEESON CJ:   I understood him to say the taxpayer borrowed this money for the purpose of on‑lending it at greater interest than the interest it had to pay to acquire it.

MR PAGONE:   Your Honour, he sort of said that.  What I think he said was that the taxpayer borrowed the money and as a matter of fact that the taxpayer lent it to a related company and received more by way.  The question was, was that the purpose of the borrowing?  That was the question that was asked both by the learned primary judge and also the Full Court.  They asked, what was the purpose of the borrowing?

What my learned friends say is that, first of all, they did not ask the question from the point of view of MFL and, secondly, that there was some impermissible taking into account of subjective purposes of the parent company in that consideration.  What we say about that, your Honour, is that there is simply no warrant for either proposition, because what the Full Court was at pains to consider was the purpose of MFL in that part of the transaction which produced an obligation to pay an amount called interest.  So that it was looking at it from a point of view of the taxpayer claiming the tax deduction.  In doing that the Full Federal Court, and also at first instance the primary judge, was at pains to consider it from a point of view of the objective circumstances, not the subjective purposes, and indeed, the very passage that my learned friend refers to, Justice Gyles at page 151, paragraph 254, that very passage ends by his Honour saying:

Here it can be said that the object of the receipt and payment of the ‘principal’, as reflected by the stapled note and the paid up preference share, was to provide MBL with Tier 1 capital although the intragroup destination was to be MLL.

So that what his Honour was doing there, as is clear throughout all of the judgments, is that what they were seeking to do was to determine the character by reference to the transaction.

GLEESON CJ:   Were they saying that it is not that you ask yourself what was the purpose of MBL, but the purpose of the borrowing had impressed upon it the character that resulted from the desire to obtain Tier 1 capital for the group?

MR PAGONE:   Your Honour, I do not think they were even putting it as in the second formulation because it was not just the desire but the actual terms of the transaction produced the consequence.  May I take your Honour to the judgment of Justice French, perhaps to make good the proposition?  It begins at 60, but the relevant part, your Honour, begins at 87.  The argument that our learned friends make here in the special leave application was the whole point of the appeal, and at 87 your Honour will see that the complaint or one of the complaints that was listed as the appellant’s complaints was that – I am terribly sorry, my learned friends are correct, at page 86.  The complaints there are numbered 1, 2 and 3, and it turned on “whether the outgoing was incurred by MFL” and so on and then they set out the contentions of the Commissioner.  Then at 88, at paragraph 85:

On the contentions advanced by the Commissioner the purpose for which MFL paid ‘interest’ to the Trustee for the noteholders is central to the characterisation of that outgoing –

So not only was it our learned friends who were saying you have to look at it for the purpose of MFL but so too were we.  Then at 96 his Honour sets out the arrangements, and paragraph 102:

At the time that they were entered into the likely effect of the various transaction documents was to enable MBL to meet a need to raise Tier 1 capital –

So the question that his Honour was looking at is, what is the effect of the arrangements?  At 103:

Under the arrangements which were reflected in the three principal transaction documents the liability of MFL to pay ‘interest’ on the notes which it issued was not tied to –

et cetera.  His Honour concludes that in respect of the first limb that it was not incurred in the business of MFL, and he does that at the previous page where, in effect, what he says is that the purpose of the transaction as a whole is one capable of being attributed to MFL.  He does this by analysing the transaction documents.  It is not quite the way my learned friend opened this morning by saying there was a borrowing, moneys were received, the moneys were placed in an activity that produced income.  There was a raising of funds in a complex way.  One provision of that complex arrangement gave rise to the obligation to pay an amount called “interest”, but it was only one aspect of the entire structure.

It was a stapled instrument incapable of being unbundled and at all times raised for the purpose of the overall borrowing.  So that his Honour said the first point is that it is not in MFL’s business this was incurred, in part because the purpose of the borrowing was a purpose of MBL and that was MFL’s purpose.  We attributed the purpose in that way because of the unbundling.  But so far as the capital argument was concerned, again what his Honour is at pains to set out is that one reaches the conclusion by an analysis of the transaction.  If one turns to page 99, for example, at paragraph 108:

In the present case the juristic character of the interest payments as obligations incurred by MFL under the transaction documents already discussed is not in issue.

What his Honour says, if I may paraphrase it, is, in effect, there are two ways of looking at this.  You can either look narrowly at the ‑ ‑ ‑

GLEESON CJ:   Is that a kind of distinction between “immediate purpose” and “ultimate purpose”?

MR PAGONE:   Your Honour, he did not need to make that distinction.  I do not think he was making that distinction.  What he was saying was when you look at the transaction documents and you ask yourself, “Do I confine myself to the fact that there is an obligation to pay an amount called ‘interest’?”, if I confine myself to that, then, yes, there is an outgoing of interest, but he says I cannot confine myself to this narrow view of the transaction because, unlike South Australian Battery Makers – that is my interposition – where the facts were really quite different, here it is a composite whole incapable of separation and incapable of producing the separate consequences which the obligation to pay the amount as interest might otherwise have produced.

If one goes to South Australian Battery Makers, your Honours, one will see that indeed that was fundamental to the outcome in that case.  May I turn just briefly to that case which is behind tab 2.  At page 651, being page 39 of the bundle, your Honours will see that the relevant lease to the taxpayer – this is about point 7 down the page:

The memorandum of lease, when finally executed, bore date 16th June 1966 . . . It did not contain, or refer to, an option to purchase the demised land.

Then if one can go to page 655, my learned friend has read the first paragraph, but if I may just draw attention to the word on the sixth line:

If the only advantage sought was the right to possession under the lease –

and so on.  But the next paragraph is also significant, your Honours, third line:

The only binding arrangement between the taxpayer and the Trust was that embodied in the lease –

The rest of the paragraph is also of assistance.  His Honour at 659 then turns to an analysis of the Europa Cases, being the distinction between direct and indirect, and at page 660 in the passage immediately above that which my learned friend referred to, about eight lines from that passage, there is a reference to the Europa Case and his Honour goes on to say:

support the conclusion that it is the advantage which the expenditure was intended to gain, directly or indirectly, for the taxpayer that is relevant in determining the character of the expenditure, and that when an expenditure is genuinely made in payment of the price of trading stock –

then the result will be assessable.  So there is an introduction of directly and indirectly.  So that what is plain is that even the South Australian Battery Makers’ Case does not support the conclusion – never has supported the conclusion that when you look at it from the point of view of the taxpayer, you must take a blinkered view of what the transaction is doing even from that point of view.  Indeed, that is both what his Honour Justice French and Justice Gyles decided and so too Justice Hill at first instance.  Justice Gyles says at page 149 in the application book at paragraph 251 – he starts off by, in the previous paragraph, saying that there seemed to be some support for some criticisms that are made and then at 251 said:

On the other hand, the primary judge was correct in finding that the ‘stapling’ of the preference shares and notes was also a feature of the transaction that could not be ignored.  The investor was both a note holder and the holder of a fully paid preference share at all times and one could not be dealt with without the other.  There was no right to demand repayment.  The rights conferred by the note might be transmogrified . . . From the point of view of both the investor and MBL (and its subsidiaries including MFL), the essential characteristics of the rights and liabilities did not alter whether governed by the note or by the preference shares after a Payment Direction Event.  The transaction can be viewed as an affair of capital from start to finish.

Then can I take your Honours to the critical passage at 150 to 151.  My learned friend has taken you to the beginning of that by saying that his Honour poses what he referred to as a sort of counterfactual, although it is a different meaning in this context, but he says you cannot look at it as being as narrow as the obligation to pay an amount because it is an intricate, tripartite arrangement and that, as his Honour says at the end of that:

In my opinion, this conclusion is not to give effect to commercial or business equivalence but rather is the result of properly analysing the effect of the transaction viewed as a whole.

So, your Honours, we say that that is simply orthodox application of established principles.  What our learned friends do not like is that the court has taken into account some bits of the transaction that they would rather not draw attention to, and not for any mischievous purposes, but simply because it points to a direction and a conclusion that they do not like. 

What they really complain about is the conclusion which their Honours have drawn about the character of the composite transaction as a whole and we say that this does not in any way detract from the decision in South Australian Battery Makers and, furthermore, that the conclusion is reached on factors that have nothing to do, nothing to do with subjective purposes of the arrangement.

Your Honours, we do also say that the matter is not an appropriate case for special leave and we have set out our reasons for that in the application book.  The provisions upon which this case turned are now no longer operative for these kinds of transactions.  There is now a new division 1974 dash something or other.  It is a provision that is referred to as the debt/equity rules and your Honours will doubtlessly be teased with all of the difficult questions raised by that division in due course.  But if we once thought that debt was easy to determine, that is certainly no longer true and the outcome of this case will certainly not assist in any way in understanding those issues. 

So far as the other cases that come up that our learned friends say are similar to this, we have attempted to respond at page 207 of the application book.  Three cases are put forward.  Two of them we say are fundamentally structurally different from this one so that the outcome in this case could not bear upon those.  That is the NAB and the AMP matter.  So far as the Colonial Case is concerned, that had a short life and, in any event, we would say that the outcome in that case depends upon a purpose of the transaction to be found on those documents which will not be helped by these ones. 

Your Honours, whilst I am in that part of the application book, at page 208 of the application book we refer to the so‑called interest being conditional and also defeasible at the unfettered discretion of MFL.  Our learned friends complain about that.  Your Honours will see that at 5.5(g) we note that MFL could bring the thing to an end of its own accord.  Our learned friend’s retort to us is at page 218, their paragraph 11.  They say that this:

(a)      was not addressed to the trial Judge;

(b)      is not adverted to in the judgments of French and Gyles JJ –

Well, your Honours, the proposition was put in our written submissions to the trial judge and we did say before his Honour that the matter was conditional and defeasible and reference was made to clause 5.5 and the

only two subclauses that could have had the effect of defeasance are (g) and (h), and the matter was argued before the Full Court, and I have transcript references if my learned friends want that. 

Your Honours, we say finally that, in any event, that Part IVA would apply, even Justice Hely who would have decided in the Full Court Part IVA against us, and Justice French agreeing, but even Justice Hely said that there was some artificiality in the way the transaction arose.  The artificiality being I want 400 million so I have a raising of 800 million, let us say two parcels, one the share subscription and the other the note, and then I give back one bundle.

GLEESON CJ:   If we had to get to Part IVA, the division in the court below would be against you on a special leave application, would it not?

MR PAGONE:   Your Honour, I think on our reading of the rules we would be able to rely upon Part IVA in order to defend the order that we would be seeking to defend.

GLEESON CJ:   You would be entitled to rely on it, but if we needed to get to that in our consideration of the suitability of the case, you would be in some difficulty, I would have thought, at this level.

MR PAGONE:   Your Honour, I do not see why.  The facts having been determined, it is, at the end of the day, perhaps just a conclusion of a statutory provision.  If your Honours please.

GLEESON CJ:   Yes, Mr Bathurst.

MR BATHURST:   Could I ask the Court to go for a moment to the judgment of Justice Hely, paragraph 187 at page 128.  His Honour there says, and we say quite correctly, with respect:

The shares and notes must be looked at as a composite transaction because that accords with the facts, but one does so from the perspective of MFL.

We have not put the proposition that one ignores this was part of a wider transaction.  What we complain about is that the majority simply did not look at it from that perspective.  South Australian Battery Makers was part of a wider transaction, and that that it was was known by the taxpayer.  That appears from page 656 of the judgment in the judgment of the Acting Chief Justice, as his Honour then was, in the paragraph which I read part, halfway down the page, he states:

However it is abundantly clear that those who managed the affairs of the taxpayer knew that the grant of the lease was part of a wider scheme designed to benefit another or other companies in the group.

Then dropping down to the foot of the page, the fourth‑last line:

Of course, as I have already indicated, a taxpayer may derive an advantage if someone else, such as a subsidiary, acquires an asset.  But the fact that someone else incidentally derives an advantage of a capital kind in which the taxpayer does not share is not enough to give the outgoings the character of capital.

It must be remembered in that regard that as far as Justice Hill was concerned, he accepted that the payment fell within section 8(1) but said, we say contrary to what was said Battery Makers, that it was an affair of capital. 

My learned friend referred to paragraph 102 of Justice French’s judgment at page 96 and particularly – the only reference there to MFL is in the last sentence in that paragraph:

The way in which MFL came to be involved in the arrangements indicates that it was there to serve the purposes of MBL and that those purposes could properly be attributed to it.

That really begs the question, with respect, every subsidiary in one sense or another is there to serve the purpose of its parent.  It does not assist looking at it as to how it assisted it or, in this case, the character of the advantage given.  So far as Part IVA is concerned, the division in the courts below was acute.  They are our submissions, if the Court pleases.

GLEESON CJ:   The characterisation of the relevant outgoing by Justice Hill and by the majority of the Full Court of the Federal Court involved the application of settled principles to the complex and unusual circumstances of the particular case.  That consideration, together with the legislative amendments referred to at page 207 of the application book, means that the case does not raise an issue suitable to the grant of special leave to appeal and the application is dismissed with costs.

MR BATHURST:   If the Court pleases.

AT 11.53 AM THE MATTER WAS CONCLUDED