Mills v Commissioner of Taxation
[2012] HCATrans 259
[2012] HCATrans 259
IN THE HIGH COURT OF AUSTRALIA
Office of the Registry
No S225 of 2012
B e t w e e n -
ANDREW VINCENT MILLS
Appellant
and
COMMISSIONER OF TAXATION
Respondent
FRENCH CJ
HAYNE J
KIEFEL
BELL J
GAGELER J
TRANSCRIPT OF PROCEEDINGS
AT CANBERRA ON WEDNESDAY, 10 OCTOBER 2012, AT 10.15 AM
Copyright in the High Court of Australia
MR A.H. SLATER, QC: If the Court pleases, I appear with my friends, MR D.F.C. THOMAS and MR G.S. ANTIPAS, for the appellant. (instructed by Herbert Smith Freehills)
MR N.J. WILLIAMS, SC: May it please the Court, I appear with MR J.O. HMELNITSKY for the respondent. (instructed by Australian Government Solicitor)
FRENCH CJ: Yes, Mr Slater.
MR SLATER: Your Honours, before I begin, may I have the indulgence for saying what a pleasure it is for those of us at the Bar table to appear before and address the first appeal in which Mr Justice Gageler sits.
FRENCH CJ: I am sure that is appreciated, but I am sure it will make no difference to the outcome.
MR SLATER: I do not think so, your Honour. Your Honours, on 14 December 2009, the Commissioner of Taxation made a determination under section 177EA of the Income Tax Assessment Act 1936, which your Honour will find at page 3 of the appeal book, and I will not take your Honours to it. By this appeal, the appellant challenges the respondent’s power to make that determination. Orally, we propose to go first to the statute, then to the statutory question, the factual and statutory context and the arguments.
We have provided your Honours with two volumes of materials, one an orange volume of the relevant legislation, and the other a rather bulkier yellow covered bundle of materials. What I propose to do with those is simply to give your Honours references to them. They include the more obscure reports which are referred to in the submissions, but I do not propose to read to your Honours anything from them today.
So, your Honours, may I then go immediately to the statute. It is in the orange bundle at page 75 and your Honours will see that it is headed “Creation of franking debit or cancellation of franking credits”. The operative provision is on page 76 of the bundle, it is subsection (5), and it provides that:
The Commissioner may make, in writing, either of the following determinations:
in paragraph (a) in the case of a corporate entity a determination “that a franking debit” be made. That is not the present case. In paragraph (b):
a determination that no imputation benefit is to arise in respect of a distribution or a specified part of a distribution that is made, or that flows indirectly, to the relevant taxpayer.
We are concerned with a distribution that is made to the relevant taxpayer. It goes on to say that:
A determination does not form part of an assessment.
So that this appeal comes as an appeal against an objection decision in respect of the determination itself and not the assessment of tax. The criteria by reference to which a determination may be made are set out in subsection (3) which begins at the bottom of page 75. The section applies if, paragraph (a), there is a “scheme for a disposition” – I will abbreviate this if your Honours will allow me to do so.
FRENCH CJ: Paragraphs (a) to (d) are not contentious.
MR SLATER: Paragraphs (a) to (d) are not contentious so if I can just pass over those, your Honour, and go straight to paragraph (e):
having regard to the relevant circumstances of the scheme, 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 a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling the relevant taxpayer to obtain an imputation benefit.
If paragraph (e) is not satisfied, then the appellant succeeds. If paragraph (e) is satisfied, then the appellant fails. There are two important questions arising out of it. The first is whether the bank, in this case the party whose purpose is in question, had a purpose of enabling the appellant to obtain a franking credit, and second, whether, if so, that purpose was more than an incidental purpose. If it was not more than an incidental purpose, then the appeal succeeds.
FRENCH CJ: I notice at paragraph 23 you have a number of terms to indicate the approach that you take to “incidental”. Do you use it in any, for your purpose, any sense other than ancillary?
MR SLATER: We say, your Honour, that the requirement is that the purpose not be an incidental purpose if it is either incidental in the sense that it is casual or unimportant, or incidental in the sense that it is ancillary or follows on naturally in either case.
FRENCH CJ: You say both of those things come out of the explanatory memorandum?
MR SLATER: Yes.
KIEFEL J: But, it is the second sense that you principally rely upon?
MR SLATER: Yes, the second sense, we say, is the more natural sense, but we say it does not matter which because the word “or” is not used as a logical disjunct but as two alternatives, either of which may be satisfied. From time to time to save my breath I will refer to the purpose that is referred to in paragraph (e) as a proscribed purpose, and that is what I mean when I use that expression, if your Honours please.
Subsection (17), which appears on page 79 of the bundle of materials, sets out the relevant circumstances which are referred to in paragraph (e). I do not propose to read them to your Honours now. They are, in our submission, not necessarily the only relevant matters. That was the view which the Full Court took. Justice Emmett took a different view, but perhaps it does not matter terribly much in the context of this case.
Of the 18 matters which are listed – and I say 18 because the last of them imports a variety of matters referred to in section 177D(b) – 12 are not relevant, do not support or tend against the proscribed purpose and are not in contest. Three were considered by the Full Court not to support a finding that the proscribed purpose was present, but the respondent by his notice of contention submits otherwise, and three were considered by the majority, but not by Justice Edmonds, to support a finding of the proscribed purpose. In our submission, the majority was incorrect so to conclude.
Your Honours, other relevant subsections of section 177EA are subsection (4), which is on page 76, and which provides that:
It is not to be concluded for the purposes of paragraph (3)(e) that a person entered into or carried out a scheme for a purpose mentioned in that paragraph merely because the person acquired membership interests . . . in the entity.
Subsection (12), which your Honours will find on page 78, which extends the reach of the section to what are deemed by the legislation to be equity. They are called “non-share equity interests”, and I will take your Honours to the origin of that expression shortly.
FRENCH CJ: But it is not contentious here that these were equity interests?
MR SLATER: It is not contentious, no, your Honour. It has never been contentious. I simply draw your Honours’ attention to that subsection to make it clear that that is the way the Act works. I will come back momentarily to Division 974.
The question at the end of the appeal, your Honours, is whether the statutory question posed by subsection (3)(e), did the bank either enter into or carry out the issue of the securities here – which are referred to by the acronym PERLS V – with a non-incidental purpose of enabling the appellant to obtain franking credits.
I say “franking credits”, your Honours, because although the statutory language is imputation benefits, the only imputation benefit that is in issue in this appeal is franking credits, and I will come back shortly to your Honours to explain what the franking credit is. But, your Honours will find the definition of “imputation benefits” in section 204-30(6), which is on pages 15 to 16 of the orange book, and again, I will not take your Honours to that now.
HAYNE J: Considering paragraph (e), is there any relevant distinction to be drawn for our present purposes between entering into and carrying out the scheme?
MR SLATER: Not for the purpose of this appeal, your Honour.
HAYNE J: What do you understand to be the connection drawn between “purpose” and either of those expressions by the Commissioner? Does the Commissioner say the bank entered the scheme for the purpose, that the bank carried out the scheme for the purpose? Does the Commissioner say both?
MR SLATER: As we understand it, your Honour, both, but that is really a question I should let my friend answer. Your Honours, it is not in contest that the bank had a purpose of franking the distributions, nor in contest that the bank had a purpose of attracting subscriptions by conditionally promising to make the frank distributions. The relevant and contested matters are whether the bank’s purpose of franking the distributions was incidental within the meaning of the parenthesis in paragraph (e), and whether the purpose was relevantly one of enabling the obtaining of franking credits. The facts in the appeal are not contested. There was no material objection to any of the evidence at trial and there was no cross‑examination. The resolution depends on the construction to the second ‑ ‑ ‑
HAYNE J: Sorry to interrupt you again, but you said that it was not in dispute that the bank had a purpose of what?
MR SLATER: A purpose of franking the distribution, I put it, your Honour.
HAYNE J: A purpose in the sense of the bank intended that that would happen?
MR SLATER: Yes.
HAYNE J: Is it not necessary to identify rather more carefully and narrowly what is meant by “purpose” in this section, observing that the bank intends to issue a particular security, intends that in the events that will happen, or are then expected to happen, that distributions will be franked? Is that sufficient to classify as “purpose”?
MR SLATER: It is not sufficient to satisfy the section, in our submission. Our friends I think take a different stance. That is why I said earlier that there is a significance in the word “enabling”.
GAGELER J: Does the word “purpose” mean anything other than intended consequence?
MR SLATER: Except that “purpose” is a characteristic of a person; “intended consequence” is a characteristic of an event. Apart from that semantic difference, no, I do not think so, your Honour. I think when one talks about a person’s purpose, one talks about the outcome which a person intends to achieve.
GAGELER J: Thank you.
MR SLATER: So, your Honours, the resolution of the appeal depends on the construction of the section, but the construction of the section in its context and having regard to its purpose. The structure of our oral argument, your Honours, will be this - and we have provided your Honours with a skeleton. The skeleton is just a mud map to the argument; it does not contain the argument so much in itself.
I will take your Honours first briefly to the factual context; second, to the statutory context, including the relationship of section 177A with each of the imputation system in Part 3‑6, and Division 974, the debt equity rules; third, to what we say about the meaning in that context of the word “incidental” in the expression “an incidental purpose”; fourth, to what we say are the errors in the Full Court’s reasoning; fifth, to the point which agitates our friends, the significance of the New Zealand tax treatment, that is, the treatment for New Zealand income tax purposes of these payments; and finally sixth, to the individual subsection (17) relevant circumstances in context.
So, may I begin, your Honours, with the first of those matters, the factual context? The appellant subscribed for the securities which, as I said, are referred to by the acronym PERLS V and I will continue to use that acronym because the full title is Perpetual Exchangeable Resaleable Listed Securities issue 5, and we do not have long enough for me to say that every time. They were issued by the Commonwealth Bank of Australia which I will refer to as the bank, if your Honours please. The bank is an authorised deposit‑taking institution under the Banking Act and is therefore regulated by the Australian Prudential Regulatory Authority which again I will refer to by its acronym of APRA. It is required to maintain a level of Tier 1 capital, and I will take your Honours to what is meant by that.
In 2009 it desired to increase its level of that capital. The Tier 1 requirements of APRA with effect from January 2008 are summarised in the primary judgment at pages 548 to 551 of the appeal book, pages 42 to 54. May it please, I will not take your Honours through that passage in detail; I simply give your Honours a direction to it.
FRENCH CJ: This was a particular class of Tier 1 capital, was it, non‑innovative residual Tier 1 capital?
MR SLATER: These particular securities fell into the category of non‑innovative, yes, your Honour.
FRENCH CJ: Incidentally, there is a diagram at 116 in appeal book 1. Is that for present purposes an accurate representation of the arrangements?
MR SLATER: Except that it is directed to New Zealand tax issues, yes, I believe it is, your Honour.
FRENCH CJ: I know that, yes. There is a box with CBA and CBANZ - are they separate corporate entities or is CBANZ a division of ‑ ‑ ‑
MR SLATER: It is just the operations of the bank in New Zealand. It is the one corporation. It is the operations in New Zealand through a permanent establishment there. “Permanent establishment” is a term which is used in income tax law to indicate a business carried on through a place. It is then taxed by the jurisdiction of incorporation and the jurisdiction of business according to that under double tax treaties.
Your Honours, what is relevant for present purposes is that Tier 1 capital must have these characteristics which are set out in paragraph 48 of his Honour’s judgment at page 549. It must be “permanent and unrestricted” in the sense that there are no repayment obligations. It must have no unavoidable service charges, meaning that it must have no obligation to pay distributions. Distributions must be at the discretion of the bank and the capital must be postponed to all creditors.
What is meant by “residual non‑innovative capital” is described by his Honour at paragraph 51 and your Honours will also find the relevant standard at page 177 of the appeal book. It is unsecured and perpetual in the sense that it has no redemption obligation, that is, there is no point at which the bank is obliged to redeem it. It must have no fixed servicing costs in the sense that I have just explained to your Honours. It must be subordinated to all creditors and to the extent that the capital includes a component which is a note, that is, a debt obligation, the debt obligation must be issued from an overseas branch of the bank and it must be stapled to a share issued by the bank itself, that is from its head office. At paragraph (d)(iv) on page 178, APRA describes that as effectively a preference share.
Your Honours, there are limits on the amount of residual Tier 1 capital which may be taken into account for the purpose of satisfying the obligations imposed by APRA. Residual capital is divided, as his Honour the trial judge explains at paragraph 53, into “innovative” and “non‑innovative” capital. The total residual capital must be no more than 25 per cent of Tier 1 capital and the innovative Tier 1 capital, which is not these securities, but other securities which, in effect, do not include preference shares, must be no more than 15 per cent of the total Tier 1 capital taken into account.
In the case of the Commonwealth Bank, the 15 per cent limitation was phased in over a period but that period expired in January 2010. Your Honours will find the evidence for that at page 48 of the appeal book in paragraph 19 and I will not take your Honours to it. But the effect of that is that because the PERLS securities were being issued in late 2009, the 15 per cent limitation applied to them or would commence to apply to them almost immediately from January 2010.
Now, your Honours, in July 2009, the Commonwealth Bank had no capacity to raise innovative capital that qualified as Tier 1, that is, it had no capacity to raise capital which did not include a preference share either in itself or stapled to a note. That was because it had already passed the 15 per cent limit which was to apply from January 2010. Your Honours will find the material concerning that in the judgment of Justice Emmett at paragraphs 58 to 60 on pages 553 to 554 of the appeal book and in the judgment of Justice Edmonds at paragraphs 23 to 24 – I am sorry, I said Justice Edmonds, it was in the affidavit of Ms Cobley at paragraphs 23 to 24 and pages 49 to 50 of the appeal book and paragraph 42 on page 53. Again, if your Honours please, I will not read those passages to your Honours.
The bank had recently raised approximately $5.9 billion and I use “billion” in the American sense, that is, thousand million, of fundamental or ordinary share capital which qualified as Tier 1 capital and that capital had to the bank what bankers call a cost of capital of 14 per cent. I am not going to explain to your Honours what “cost of capital” means. I am sure I would get it wrong and mislead your Honours but those with economics qualifications will probably know better than I what it means. I do not want to embarrass myself.
Your Honours, the basis for that is on page 51 of the appeal book and also in the table at paragraph 6.3 on page 243 of the appeal book. Its capacity for further non‑innovative Tier 1 capital, which could be raised at a lower cost of capital of 5 per cent to 9 per cent, was enhanced by the issue of that ordinary capital and the bank sought to raise further Tier 1 capital to meet its business needs at that lower rate and with the benefit of the diversity which the innovative capital provided. By “diversity” I mean that it was capital at a floating semi‑fixed rate rather than ordinary capital which carried an obligation to pay dividends out of profits generally. Your Honours will, again, find that at page 243 of the appeal book.
The bank had a need for additional Tier 1 capital because some of its older Tier 1 securities had reached the point at which they had to be either redeemed or converted into expensive ordinary capital, and also at the same time what is referred to as “the global financial crisis” was gaining momentum. So, the decision was made to issue new non‑innovative Tier 1 capital, which is the PERLS V securities presently in issue.
Now, your Honours, the respondent regards it as important to his case that the bank could have issued other Tier 1 capital than the PERLS, and we do not dispute that that is so. He also makes the point that it issued the PERLS because they offered a lower cost and, again, we do not dispute that that is so. We say also that they offered the benefit of diversification which is referred to.
But both the diversification and the lower cost and in particular the lower cost, which is the fulcrum of our friends’ submission because the lower cost derives from the New Zealand tax consequences at least in part, the lower cost, in our submission, was unrelated to the franking of the securities and, for reasons which I will come to in a moment, all of the options available to the Commonwealth Bank necessarily carried an obligation to pay distributions and to frank them. I will explain to your Honours how it is that Part 3‑6 imposes that effective obligation.
Can I turn then briefly to the terms of the securities? They are summarised in the primary judgment at paragraphs 19 to 32, which is on pages 541 to 545 of the appeal book, and they can be found in more detail in the prospectus beginning at page 283 in volume 2 of the appeal book. Again, I do not propose to take your Honours to any of those passages in detail. May I point out to your Honours the main features? The bank issues a preference share which was stapled to a note issued by the New Zealand branch or permanent establishment of the bank. When I say “by” I mean issued out of the New Zealand branch.
HAYNE J: In what sense issued out of the New Zealand branch, Mr Slater?
MR SLATER: The steps comprising the issue were taking in New Zealand, it was issued to the original holder, which was a Macquarie Bank entity in New Zealand, and then transferred by that entity to the ultimate holders. So, in that sense, it satisfied the requires of APRA that it be issued through a branch outside Australia, and that is the sense in which I use the expression, your Honour. For reasons to do with security law, that is that no prospectus was registered in any other jurisdiction, it was only offered to Australian subscribers, and your Honours will find an account of that in the majority and minority judgments in the Full Court.
The distributions which were to be paid on the securities were non‑cumulative and were in the discretion of the bank, and that satisfied the requirements of APRA. There was an effective promise to holders that they will get their distributions in that if the bank did not make the distributions on these securities it could not make distributions on any other securities ranking behind them. The securities were transferrable, or as the acronym says, resalable, and they were listed on the Australia Stock Exchange. There were some 33,000 investors in these securities and the amount raised was in fact precisely $2 billion.
So that this was not a hole in the corner arrangement or an internal arrangement of the type encountered, for example, in the Spotless Services Case or the Consolidated Press Case. This was a public issue of securities available to be traded on the stock exchange. After 15 years the securities would convert to ordinary shares. The number of ordinary shares would be the face value of the securities divided by the then prevailing price of ordinary shares, subject to a limitation which is imposed by APRA.
In the meantime, the holders have no rights to redemption and they may be subjected to conversion into ordinary shares if various adverse events occur to the bank, and those again are summarised in the judgment. The distributions, if made, were to be franked. The rate of distribution was the bank bill swap rate plus 3.4 per cent, so it was a floating rate, a semi‑fixed rate, but it was reduced by the rate of tax paid by the Commonwealth Bank. If one can use this particularly horrible expression, it was grossed down by the tax rate.
The effect of that was that the investors would get cash from the bank to the extent of the actual distribution, and because the distributions were franked, they would get a franking credit from the Commonwealth. That is to say, they would get a share through the franking system of the tax which had already been paid by the bank. If for any reason the distributions were not franked, or could not be franked, then the bank was obliged to gross them up, and I apologise for that expression, but it is the shortest way of explaining it. They were to be multiplied up by one minus the tax rate.
The effect of these terms was that these securities were commercially equivalent to preference shares. The holders had no right of repayment. They were deferred to all creditors. The yield on the securities was a floating rate, that is, a rate fixed by reference to a variable rate of yield. The yield was to be franked and the securities ranked ahead of ordinary shares but conferred no share in surplus profits or surplus assets of the bank. So, your Honours, that is the substance of the terms of the PERLS V. I apologise for cantering through them at that pace but they are fully set out in the judgments below and in the evidence.
There is one other aspect of the facts which the Commissioner regards as significant but which we do not. May I take your Honours to that briefly now, and that is the New Zealand treatment of the distributions. The Australian income tax legislation taxes capital according to its economic substance. That is expressly provided for in Division 974, which I will take your Honours to momentarily. New Zealand has what is regarded in tax circles here as a more primitive system. It taxes capital according to its legal nature, rather than its economic substance, and in New Zealand, the cost of funds raised as debt for use in the business of a taxpayer is deductible to the taxpayer.
The funds raised by the issue of the PERLS V were used in the activities of the New Zealand branch of the bank. The New Zealand Commissioner was asked for a ruling on the consequences under New Zealand tax of that. The application for ruling is that that – it contains the diagram that your Honour took me to. The New Zealand Commissioner was told of the attitude of the Australian Commissioner, including the Australian Commissioner’s attitude to section 177EA, but ruled that for New Zealand tax purposes, the interest on the notes was deductible from New Zealand income. In consequence of that – and there is no dispute about this – the bank enjoyed a reduction in the sense that it was taxed only on its net profits, and not on its gross income, in its New Zealand tax liabilities. There was no reduction in Australian tax in consequence of that.
This is the significant point about the New Zealand tax treatment. It results in no saving or avoidance of Australian tax, not for the bank, not for the investors. I will explain to your Honours shortly how the investors are taxed. The franking credits on the securities which are in issue, the PERLS V securities, come entirely from tax paid by the bank in Australia. They come through the bank’s franking account – I will take your Honours to how that is dealt with – which records the tax paid directly or indirectly by the bank in Australia. The franking of these securities depletes the franking account and reduces what is available to the bank for the franking of future securities and thus, in effect, reduces the advantages which may be extended to investors in respect of future distributions.
What happens in New Zealand is entirely irrelevant to the operation of the Australian Act, except to the extent that Australia does not tax income which has been taxed in New Zealand. Your Honours will find the section which provides for that, section 23AH to which my friend I am sure will take your Honours in more detail, at page 65 of the legislation booklet.
We expect, based on our friend’s submissions, that your Honours will be told repeatedly that the distributions on the PERLS V were frankable and deductible. It is an expression which recurs in our friends’ submissions. What your Honours have to remember when your Honours hear that expression is that what it means is that under Australian tax law they were frankable and under the quite different New Zealand tax law they were deductible.
The elision of the two into one, which occurs in the majority judgment, in the judgment of the primary judge and in our friends’ submissions, is mistaken. They are not frankable and deductible under either system. They are frankable under one and deductible under the other. Your Honours should, in hearing this argument about frankable and deductible, remember that, while the bank could have chosen not to issue a security yielding a tax deduction in New Zealand, it could not have chosen to issue a security the distributions on which were not frankable and which were not therefore, by the operation of Part 3‑6, effectively obliged to be franked.
FRENCH CJ: The legal form of the distributions to the investors was interest on the subordinated notes, was it not?
MR SLATER: Yes, it was, your Honour.
FRENCH CJ: But that is treated as a frankable distribution?
MR SLATER: In Australia but not in New Zealand. In New Zealand it is treated as an interest expense. Your Honours, may I then take your Honours to the legislative context in three stages. First briefly, the context of Part IVA; second, the wider context of the Assessment Acts, including in particular Part 3‑6 and Division 974; and third, in the context of the purpose and scheme of Part 3‑6.
As to Part IVA, the object of Part IVA, in our submission, is indicated by the heading to it, and your Honours will find that on page 69 of the legislation booklet. It is “Schemes to avoid tax”. Now, our friends say that tax avoidance in this context means that which is dealt with in Part IVA and to a degree that is a correct statement. That is, we agree that the content and operation of Part IVA is determined by its language and not by any non‑statutory notions of tax avoidance. But we say that Part IVA is not enacted to make a structural change in the operation of other parts of the Act. What it is enacted for is to protect the operation of other parts of the Act, not to limit their scope.
We say that this is a relevant matter of context when construing the language of the provisions of Part IVA, and in particular those of section 177EA. I do not propose to take your Honours at length to the extrinsic matters in relation the section, but there is one passage to which I do wish to take your Honours. The extrinsic materials are in the back of the yellow volume, and that one passage I wish to take your Honours to is from the original bill for the inclusion of the section. Now, that is at page 440 of the bundle, or more accurately, at page 439, but the passage I wish to take your Honours to is at page 440. Your Honours will see, at about point 3 of the page:
Schedule 8 of the Bill will amend Part IVA . . . to prevent franking credit trading and dividend streaming. The amendments will:
·introduce a general anti‑avoidance provision which targets franking credit trading and dividend streaming schemes where one of the purposes (other than an incidental purpose) of the scheme is to obtain a franking credit benefit –
Now, your Honours, that observation relates to the section as it was introduced and put to Parliament in 1997 and enacted after Parliament had been prorogued in 1998. It was re‑enacted in 2003, but there was no material change in its content, although the subsections were renumbered. Your Honours will find the Act re‑enacting it at page 426 of the additional materials and the explanatory memorandum to that Act at page 525. But, again, I do not propose to take your Honours to those in detail.
The only material change in the section was made in 2007 when paragraph (ga) was added to subsection (17), and I will come back later in our submissions to the reasons for that in connection with our friends’ notice of contention, although the Full Court does deal with that at some length.
Your Honours, could I then turn to Division 974? The effect of Division 974 is summarised by the primary judge at pages 539 to 541 of the appeal book in volume 2, in paragraphs 14 to 18. I do not propose to read that to your Honours, but may I commend it to you as a succinct and accurate summary of the operation of that division? As his Honour says, at about line 30 on page 539, the focus of the division is on “economic substance” and not on “legal form”. So that, a decision was made in the administration of Australian income tax law to concentrate on substance rather than form in connection with the raising of capital, whether equity or debt, by taxpayers in Australia.
The consequence of that is that Tier 1 capital for APRA purposes, despite its form in the present case as including an interest bearing note stapled to the security and despite the fact that the distributions were made in the legal form of interest on that note, is treated as equity and not as debt for tax purposes. A consequence of that is that the interest is expressly made non‑deductable for Australian income tax purposes by section 26(26) and it is expressly made subject to the franking provisions in Part 3-6 and so much is and always has been common ground.
The imputation provisions treat it as equity in Division 202 which I will come to shortly. In section 202-30 and section 202-40 which are on page 5 of the legislation book, the distributions are made frankable. In contrast, in section 202-45(d) which is on page 6, non‑share dividends, that is, distributions on equity which is not in the legal form of shares – I am sorry, I have put that around the wrong way, I apologise – non‑share dividends are not frankable. If your Honours will bear with me I think I have tangled myself up in putting that ‑ ‑ ‑
HAYNE J: Where are we in the legislation book?
MR SLATER: We are at ‑ ‑ ‑
HAYNE J: Page 5?
MR SLATER: Page 6, your Honour. I shortcut myself when I said non‑share evidence. What I meant to say was distributions in respect of a non‑equity share. Your Honours will see that at paragraph (d) at about point 3 of the page. I apologise for misleading the Court in that way.
FRENCH CJ: Once it is common ground that the relevant securities are equity interests under Division 974, do we have any further concern about the operation of 974?
MR SLATER: No, your Honour. I am just telling your Honours this so that your Honours will know what the background is and how it comes about. I do not propose to make any further submissions on it. Materially, for the present appeal, the treatment of the PERLS V as equity is inevitable. It is not a matter of the bank manipulating the Act to have them treat it as equity.
Anything which the bank did to raise Tier 1 capital would necessarily result in the securities issued by the bank being treated for tax purposes as equity because the effect of the combination of the prudential regulation authority standards and the operation of Division 974 is that Tier 1 capital must be equity for income tax purposes.
Can I then take your Honours to Part 3-6? Your Honours will find a summary of this part of the Act in the reasons of the primary judge at paragraphs 7 to 13 on pages 537 to 539, and there is a legislative summary in the guide to Division 200 on page 1 of the appeal book. I do not propose to take your Honours through what his Honour Justice Emmett said. I will however take a little time to draw your Honours’ attention to some of the provisions of the Act. Section 200-5, in the middle of page 1 of the legislation booklet:
The imputation system partially integrates the income tax liabilities of an Australian corporate tax entity and its members by:
(a)allowing the entity, when distributing profits to its members, to pass to those members credit for income tax paid by the entity on those profits; and
(b)allowing the entity’s Australian members to claim a tax offset for that credit; and
in paragraph (c), “to claim a refund”. That is not a matter with which your Honours need concern yourselves in this appeal.
FRENCH CJ: That concept of partial integration reflects the fact that some franking credits will be wasted according to the particular tax profiles of members?
MR SLATER: Yes, your Honour. Certainly, that was so in the original version of imputation. The objects are expressly stated – perhaps before I go to the objects, can I just draw your Honours’ attention to section 200-10, which describes very briefly what franking a distribution is. Section 200‑15, “The franking account”:
A franking account is used to keep track of income tax paid by the entity –
That is, it keeps track of the net overall balance, not of particular receipts or payments. Section 200-20 deals with how a distribution is franked. Section 200-25:
A corporate entity must not give its members credit for more tax than the entity has paid –
and subsection (1) summarises that as being that:
(1)A corporate tax entity must not frank a distribution from profits with a franking credit that exceeds the maximum amount of income tax that could have been paid by the entity on the profits distributed.
(2)If a distribution is franked in excess of this limit, the entity will be taken to have franked the distribution with the maximum franking credit –
That is, the franking credits will be read down to the amount of the distribution. The benchmark rule is dealt with, or is summarised, in section 200-30 –
All frankable distributions made within a particular period must be franked to the same extent. This is the benchmark rule‑
and I will take your Honours to the language of the statute in a moment –
It is designed to ensure that one member of a corporate tax entity is not preferred over another by the manner in which distributions are franked.
Section 200-35 deals with the effect of receiving a franked distribution, and rather than reading that to your Honours, I will take your Honours to Division 207. Section 200-40, I do not need to trouble your Honours with the subject of 200-40 because it does not directly arise in this appeal, but what it concerns is distributions by one corporation to another where not only does Division 207 operate but also the franking credit is carried through to the recipient corporation’s franking account. I said I would take your Honours to section 201-1. Subsection (1):
The main object of this Part is to allow certain corporate tax entities to pass to their members the benefit of having paid income tax on the profits underlying certain distributions.
I will explain to your Honours in a moment how that is done, but can I tell your Honours that “distribution” in this context is defined in section 995 to include “non-share equity distributions”, which in turn are defined in section 960-120. The distribution in section 995-1 is at page 162 of the legislation booklet.
The definition in section 960-120 is not in the legislation booklet, I am sorry, but if I can tell your Honours very briefly, the relevant part of it is that a distribution includes in the case of a company a dividend, or something that is taken to be a dividend, under the Act. The other objects of Part 3‑6 are said in subsection (2) to be to ensure that:
(a)the imputation system is not used to give the benefit of income tax paid by a corporate tax entity to members who do not have a sufficient economic interest in the entity –
“Members” in this context includes both preference shareholders and the holders of non‑share equity, and the holders of non‑share equity are expressly provided for in Part 3‑6. I will come to that in a moment, but an instance of that is section 202‑30. Paragraph (b) of subsection (2), another object, is that:
the imputation system is not used to prefer some members over others when passing on the benefits of having paid income tax –
and paragraph (c), membership is not to be manipulated. Your Honours, provisions to note in Part 3‑6, Subdivision 207‑A, which is at page 30 of the appeal book, and may I draw your Honours’ attention in that to the guide at section 207‑10 and the general rule at section 207‑20.
Without reading those to your Honours, the effect of these provisions is that when an investor receives a franked distribution, the amount of the franking credit is added to the investor’s taxable income and the investor gets a credit against tax for the amount of the franking credit, so there is a gross up and then a credit against tax. The effect of that is to pass through to the member the position that the member would have been in had the member derived the income directly and paid the tax paid by the company.
Can I then take your Honours to Subdivision 202 which is on pages 5 to 6 of the appeal book and draw your Honours’ attention to section 202‑30, the benchmark rule, and this is of some significance in the appeal, “All frankable distributions made within a particular period” – I am sorry, I was reading to your Honours from section 200‑30.
FRENCH CJ: What page of the legislation book?
MR SLATER: My apologies, your Honour, page 8 of the legislation book, 203‑5:
(1)A corporate tax entity must frank all frankable distributions made within a particular period at a franking percentage set as the benchmark for that period.
That is benchmark rule. The benchmark franking percentage is set by reference to the first frankable distribution. Now, in this case, the bank had fully franked its other distributions and would continue to fully frank its other distributions, so that the benchmark would be fully franking all distributions made. The consequence of that was that the distributions on the PERLS V securities were required also to be franked at that rate.
The consequences of not franking at the benchmark rate are dealt with in section 203‑50, which is on pages 10 to 12 of the legislation booklet and, in short terms, if a distribution is made in breach of the rule then if it is franked at a greater rate:
the entity is liable to pay over‑franking tax –
That is paragraph (a) at the top of page 11. If it is franked at less than the benchmark rate then it is treated as if it had franked at the benchmark rate for the purposes of calculating its franking account, but the investor does not receive the benefit of the franking credit. So a debit is made to the company’s franking account at the benchmark rate even if the company does not fully frank or does not frank at the benchmark rate.
The consequence of that is shown in the example which begins at the bottom of page 11 and goes over to page 12. I will not take your Honours through that. The consequence of that is the distributions on the PERLS V securities had to be franked at the same rate as those on ordinary shares otherwise the bank and its investors would be penalised by forfeiting franking credits.
I should mention to your Honours briefly Division 204. It is common ground that it is not applicable here. It deals with a case where a transaction has the effect of dividend streaming whereas section 177EA deals with a case where a transaction is entered into by a party with the purpose of dividend streaming. I should also mention to your Honours Division 205, which your Honours will find on page 19. That deals with the franking account. If your Honours would look at page 20, section 205‑5, and section 205‑10. Subsection (1):
Each [corporate] entity . . . has a franking account.
Subsection (5), at about point 5 of the page:
Franking deficit tax is payable if the franking account of an entity is in deficit –
That is, if it has franked distributions to a greater extent than the balance of its franking account. Section 205‑10 provides for the constitution of a franking account. Section 205‑15 provides for what is credited to it, and section 205‑30 provides for what is debited to it. Then finally, your Honours – sorry, not quite finally, section 205‑45 provides for franking deficit tax, which I have mentioned to your Honours, at about point 8 of the page on page 26:
An entity is liable to pay franking deficit tax . . . if its franking account is in deficit –
Finally, your Honours, section 215‑10, which is relied upon by the respondent at least in passing in its submissions. Can I give your Honours a momentary legislative history of that? It replicates section – your Honours have to count the “As” here - section 160APAAAA of the 1936 Act. Your Honours will find the Act enacting that section at page 393 of the yellow volume, and the explanatory memorandum at page 529 of the explanatory volume. It was enacted in 2001 as part of the enactment of the debt equity rules in Division 974, and its purpose was to avoid a disadvantage in respect of funds raised and used offshore for an authorised deposit‑taking institution complying with APRA’s requirements.
Your Honours will find the explanation of that at page 532 of the yellow book. It is only applicable to capital which is, as a whole, non‑share equity. To explain that to your Honours I will need to take your Honours very briefly to the section itself, which is at page 33 of the orange book, and it provides that:
A non‑share dividend paid by [in effect, a bank] . . . is unfrankable if:
(a)[the bank] is an Australian resident; and
(b)the non‑share dividend is paid in respect of a non‑share equity interest that . . .
forms part of the ADI’s Tier 1 capital . . .
(c)the non‑share equity interest is issued at or through a permanent establishment . . . in a listed country; and
(d)the funds . . . are raised and applied solely for one or more of the purposes permitted under subsection (2) –
The material points in that definition are paragraphs (c) and (d). The section applies only to capital which, as a whole, is non‑share equity.
In this case, the PERLS V, as a whole, were non‑share equity and it applies only to capital which, as a whole, is issued off‑shore. Any stapled security which qualifies for Tier 1 non‑innovative status must because of the requirements of APRA include a preference share issued directly by the bank. Your Honours will find that requirement on page 178 of the appeal book in paragraph (d)(i).
The consequence of that is that non‑innovative Tier 1 capital cannot meet the requirements of section 215‑10(1)(c). Innovative Tier 1 capital can, but non‑innovative capital will be issued partly in Australia. That section 215-10 did not apply to non‑innovative Tier 1 capital such as the present securities was common ground both at trial and in the Full Court.
The reasons are explained and the position is confirmed by the Commissioner in a published draft ruling which was published in July 2009. That ruling is found at the back of the yellow volume at page 543. I should tell your Honour that that ruling was not put in evidence at trial because this section was not relied on at trial in the manner in which it is now relied on by our friends. That is notwithstanding that the case for the appellant at trial was that these distributions were required to be franked. That is, the case was the same as it is here.
We do not submit that it is not open to the respondent to argue the meaning of the Act in this Court, but what the draft ruling does is to explain why the argument, which we understand is put here, was not put at trial and why the parties proceeded at trial on the basis that it was common ground that the bank could not have issued Tier 1 securities which did not carry a frankable yield.
We provide the draft ruling to your Honours as a summary of the reasons why section 215-10 does not apply to non‑innovative Tier 1 capital. It is a summary in the respondent’s own language. In particular – I will not take your Honours to it now but when your Honours look at it – at paragraphs 7 to 8 on pages 544 to 545 of the yellow volume, your Honours will see that the example in the ruling is specifically the example of the PERLS V securities. That is, it concerns a bank issuing stapled securities through a New Zealand branch.
Now, your Honours, section 215‑10 is, in consequence of the reasoning which is explained in the draft ruling, only applicable to innovative capital. It does not apply to capital which includes a preference share issued by the bank. The reason why it was not at issue at first instance is that the bank already had more innovative capital on issue than could qualify for Tier 1 purposes. So the bank could issue innovative capital but it would not qualify as Tier 1; it would be relegated under APRA rules to Tier 2, so it would not satisfy the bank’s need. That was, as we understood it, always common ground.
Your Honours, if I may revisit the essential facts in this legislative context, the bank perceived a need for more Tier 1 capital. It wanted it at a lower cost and more diversified than ordinary shares could provide. The only capital it could raise that qualified for that purpose as Tier 1 capital was ordinary shares or preference shares or preference shares stapled to yield bearing notes issued from a foreign branch. Whatever Tier 1 capital, whether shares or notes, the bank raised, would necessarily be treated as equity for Division 974 purposes and for imputation purposes. It had already franked and would continue to frank its other distributions, so it was required to frank its new distributions at the same rate and if it did not, it would be treated, in effect, as if it had done so. So, effectively, if not in explicit terms, the Act required it to frank the distributions on its new capital.
The relevance of Part IVA to these essential facts, in our submission, is this: that the outcome which, in our submission, occurs in relation to these securities that the bank was required to and does frank the PERLS distributions, is what the Act in Part 3‑6 and Division 974 sets out to secure and we submit that is not an appropriate case in which to invoke the anti‑avoidance provisions of Part IVA. We submit that the franking of the distributions is an inevitable incident of the issue of more Tier 1 capital. Whatever capital the bank issued that qualified as part of its Tier 1 capital, the distributions on it would be franked.
In our submission, whatever else may also be said about it, the purpose of the bank to frank distributions on the new capital, the PERLS V capital, was incidental to the purpose of raising capital by issuing those securities. So, in our submission, it fell within the parenthetical exception in paragraph (e). Your Honours do not need reminding of the relevant principles for construing legislation. They are referred to in the written submissions and in the judgments below. The relevant phrase, at page 76 of the orange book, is that a person entered into a scheme:
for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling the relevant taxpayer to obtain an imputation benefit.
“Incidental” has two potentially relevant meanings. We have given your Honours dictionary definitions at page 537 of the yellow volume, and they are in much the same terms:
happening or likely to happen in fortuitous or subordinate conjunction –
liable to happen in connection with; naturally appertaining to.
That is the Macquarie Dictionary, and similarly, on page 539, the Oxford Dictionary. The two available senses that are relevant to the present appeal of the word “incidental” are these: one is fortuitous, casual, trivial or incidental, and that is the meaning which the majority in the Full Court adopted as the meaning of the word. The other meaning is – and again, this is paraphrasing the word and your Honours are aware of the difficulty which is involved in substituting one word for another in a statute – but the sense is conveyed by phrases such as “in subordinate conjunction”, “ancillary”, “consequential”, “in furtherance”, “naturally appertaining to”, or “following another purpose as its natural incident”.
The authorities which are set out in our submissions at paragraph 23, copies of which are in the volume of materials, are illustrative of these different uses in different statutory contexts. The contexts are quite different. The only purpose of taking your Honours to them is to show that both meanings are open according to context.
FRENCH CJ: How does the mischief to which the section is directed, which you set out I think at 4(b) of your outline, inform the constructional choice in relation to incidental purpose?
MR SLATER: In two ways, your Honours. One is that the mischief directs attention to an intent to achieve something which subverts the operation of the act, and that intent is by its nature not just a casual consequence, it is an intent to do something. Perhaps the other way I was going to put it is really another way of saying the same thing. While incidental in the sense of fortuitous, chance or trivial is a possible instance, it is more naturally something related to consequence than to purpose. It is more naturally related to an event than to an intent.
Purpose involves the idea of a relevant relationship with the act or transaction. It does not, we think, import merely chance or fortuitous. It asks whether the purpose is incidental to something else. The chance sense lies perhaps in the realm of the abstract of possibility or probability. The ancillary or following‑on sense lies more in the realm of the purpose of the actor or party to the scheme that is in issue. When you look at paragraph (e), the context in which the parenthesis appears is that one of the persons who entered into the scheme did so for a purpose. We submit that that context, the purpose of a person, imports intent rather than chance.
FRENCH CJ: Does the purpose of enabling the relevant taxpayer to obtain an imputation benefit run wider than what would be necessary to cover franking credit trading and dividend streaming?
MR SLATER: It is not limited to that, your Honour. We do not submit that it is. We rely on the explanatory memorandums referenced to those things to indicate the general intent of the section and to provide illumination to its construction, but we do not submit that it is confined to those ‑ ‑ ‑
FRENCH CJ: So it does not necessarily help us with the constructional choice on incidental to ‑ ‑ ‑
MR SLATER: It helps us to the extent that it indicates that the section is concerned with intent and to contrast between section 177EA on the one hand and Division 204 and its predecessor on the other shows that 177EA is concerned with the intent of a party. Division 204 is concerned with the consequence of an event, and the chance sense, if it were material, would be more appropriate to the consequence of an event rather than to the intent of a party. That is what we submit.
But we also submit, your Honours, that it does not matter. It is not an either/or choice. All that is required to invoke the parenthesis and take the purpose outside paragraph (e) is that in some sense or other, it is incidental. It is not a matter of one or the other. There is no dichotomy here. Either will do.
That is apparently what was intended by the legislature insofar as intent can be divined from the extrinsic materials and there is, we think, enough ambiguity here to warrant recourse to the extrinsic materials. Can I take your Honours to page 454 of the yellow volume, the explanatory memorandum to the original Bill at about point 4 of the page where an explanation is given of “Incidental purpose”, paragraph 8.76, the first sentence:
A purpose is an incidental purpose when it occurs fortuitously or in subordinate conjunction with another purpose –
Those are the words of the Oxford Dictionary. In the next bit:
or merely follows another purpose as its natural incident.
Now, we submit that any of those senses of the word “incidental” will do to attract the operation of the parenthesis and take the purpose of the person concerned, in this case the bank, outside the operation of the paragraph and therefore of the section. In our submission, where his Honour Justice Jessup went wrong was by implication to frame it as a choice of one sense or the other. It could only be one or the other, is the underlying thread in his Honour’s reasoning. That, in our submission, is a mistake. Can I then come to the fourth section of our submissions, the errors in ‑ ‑ ‑
HAYNE J: Just before you depart from this, and staying with this explanatory memorandum, we see in paragraph 8.74 at page 453 a description of “Determining purpose”. It is described as:
did so for the purpose of obtaining a tax advantage relating to franking credits.
Whether or not that is a sufficient or necessary element in the relevant identification of purpose, the statutory description of the purpose is a purpose of enabling the relevant taxpayer to obtain. As I understand it, the argument that you are seeking to meet is an argument that would identify purpose of enabling as satisfied by observing that these securities provide returns that will be franked. Is that right?
MR SLATER: That appears to be the way the respondent puts his case, but, your Honour, I do not want to frame my friend’s submissions for him. That appears to be the underlying thread that one has regard to the consequence more than to the purpose. So, he says you determine purpose objectively by what happened.
HAYNE J: The reason I raise it with you is the way in which you opened the appeal by identifying what you said could be identified as a purpose of this issue. You referred, did you not, as a purpose being in some way related to paying of franked returns on the investment? Is that right, or do I misunderstand what you conveyed in your opening?
MR SLATER: I do not think so, your Honour. We do not dispute that the bank intended that these distributions be franked as they would have to be under the operation of Division 203 and that to the extent that “intent” conveys purpose, it had that purpose.
HAYNE J: Well, it is to that point I am directing your attention, whether intending that returns on the investments will be franked can be described as a purpose of enabling. Now, I understood your argument to proceed from at least an acceptance that that is a possible point of view. Is that right?
MR SLATER: Yes. We do not put it that the bank did not intend that these distributions be franked and we do not put it that it cannot be said that a subscriber who acquired the shares was thereby enabled to get the franking credits on the distributions. But what we do say ‑ ‑ ‑
HAYNE J: You point to the fact that (a) the bank required Tier 1 capital, (b) if it was to raise Tier 1 capital it was either going to be ordinary capital or this particular form of capital and whichever form of capital it was, it was going to be franked.
MR SLATER: Yes. What we do say is that when one reads section 177EA and reads the phrase a:
purpose but not including an incidental purpose) of enabling –
one construes it having regard to what is said. For example, in the passage which your Honour read to me from paragraph 8.74, one cannot substitute the words “tax advantage” in the explanatory memorandum for the language of the statute but they do convey an idea of what the section is aimed at, something which is done probably in a manipulative sense to enable a tax advantage to be obtained.
HAYNE J: The enabling is the only word relevantly which may carry this manipulative flavour with it, may it not?
MR SLATER: We say this is not, in that sense, an enabling. This is not ‑ ‑ ‑
HAYNE J: There is no enabling where the inevitable consequence of the decision to issue capital is in the events that happened that franking will be paid.
MR SLATER: Perhaps more accurate, your Honour, no enabling within the meaning and intendment of this paragraph. That is an important part of our case.
HAYNE J: Yes. I diverted you from your course.
MR SLATER: I was going to take your Honours to what we submit are the errors in the majority reasoning. The principal error in the majority of reasoning, in our submission, is the one to which I have already adverted, and that is that it seems to us that Justice Jessup ascribed to the word “incidental” the fortuitous or chance sense to the exclusion of the subordinate conjunction or following as an incident sense, and found, as we do not dispute, that franking the distributions was important to the bank and important to the investors, and so his Honour concluded that it was not incidental.
The relevant passages from his Honour’s reasoning are at pages 667 to 668 of the appeal book in paragraphs 197 to 199, and at pages 675 to 676 in paragraphs 219 to 221. The conclusion is at the latter part of his Honour’s judgment in pages 675 to 676. I draw your Honours’ attention to the first two sentences of paragraph 221. His Honour says:
I have found the circumstance referred to in para (f) of subs (17) most helpful –
and he refers back to what is said in paragraphs 196 to 199, and then concludes –
once the appellant’s point that it was a complete answer to the Commissioner’s case that the raising of Tier 1 capital would necessarily have involved him obtaining imputation benefits is rejected, there is nothing in the subs (17) circumstances which is inconsistent with the existence of the non-incidental purpose –
any change in the financial position of any person –
here relevantly obviously the bank –
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 –
Well, we rely on the overall change in financial position of the bank and we say, in partial answer to your Honour Justice Kiefel, that while this is not as direct an answer as (ga) is, if (ga) is to be construed in the way for which we contend, this is nevertheless something that looks quite directly to the overall financial position of the bank, perhaps most directly of all of the circumstances in 177D(b), and that it is (vi) that is the most relevant of the criteria in 177D(b).
GAGELER J: When the word “change” is used in that context, what is the “before” and what is the “after”?
MR WILLIAMS: Before the transaction, and after the transaction. It is the implementation of the ‑ ‑ ‑
HAYNE J: The bank raised capital.
MR WILLIAMS: Yes, raised it in a way that allowed it to raise it – I am being repetitive – at a cheaper cost of capital by reason of the source. That is the matter we emphasise.
GAGELER J: That is really not comparing “before” and “after”, is it? It is comparing “after” with an alternative “after”.
MR WILLIAMS: That aspect might be comparing an alternative “after” ‑ ‑ ‑
GAGELER J: A counterfactual, perhaps?
MR WILLIAMS: Yes.
HAYNE J: The bank could have organised its affair in a way in which it paid more tax.
MR WILLIAMS: We do not put it in that way.
HAYNE J: Not as bluntly.
MR WILLIAMS: We certainly do not put it that bluntly, but we do say that the bank as a result of this transaction achieved a capital raising on particular terms, and terms that were favourable. That may involve, as your Honour Justice Gageler points out, some element of broader comparison to something else, but the actual comparison is to the bank’s position before raising the capital and after. It is relevant to consider
whether the terms were favourable or not, and we say they were for the reasons we have elaborated. Unless there are matters your Honours wish to raise, those are our submissions.
FRENCH CJ: Thank you, Mr Williams. Yes, Mr Slater.
MR SLATER: Thank you, your Honours. Your Honours, I notice reply is necessarily a somewhat discontinuous affair. I will endeavour to give some structure to our reply by reference to my friend’s skeleton argument, but the task is made a little more difficult by the circumstances that the argument, as has been put orally, has precious little to do with either the majority reasons or the case as it was put in writing.
So if I could go first to paragraph 1(a) of my friend’s submissions. The argument he put implies and depends upon the idea that franked dividends can be traced to their source. Justice Edmonds shows at pages 610 to 611 of the appeal book in paragraphs 27 to 29 why that is simply not the way the Act works. Your Honour Justice Bell put it to my friend that that passage had to be responded to, and with respect to my friend, there was no answer offered to that analysis.
Related issues arise in connection with paragraph 2(d) of my friend’s skeleton and I will come back to them. As to paragraph 1(b) and the relationship between section 177EA and Part 3‑6, we accept of course that section 177B has effect according to its terms. The way my friend put it was, to the extent to which section 177EA operates, it overrides Part 3‑6, and we agree with that.
But the question for determination in this appeal is, to what extent does section 177EA apply? What is the scope of paragraph (e) and what is the scope of the parenthesis? Merely to advert to section 177B does not in any way illuminate the answer to those questions. Some illumination was cast by the examples which your Honour Justice Hayne gave, to which, in our respectful submission, there was no satisfactory response.
As to paragraph 1(c), we say two things about this debate about alternative postulates and counterfactuals and I said them orally this morning so I will not repeat them except in the briefest of summary. First, we say, that to a large extent it is misdirected. It is not really a case of counterfactual, it is a case of looking at whether, as we put it, the franking of distributions was an inexorable incident in the circumstances in which the bank found itself of raising Tier 1 capital.
Whether the course which the bank took, whichever course it took, would involve franking distributions as a natural incident of the raising of capital and that is what makes it relevant to the question posed by the parenthesis to section 177EA. This is not a question which arises under section 177C(1).
The other thing we say about it is that the consideration of other possibilities is material to considering the question of a purpose of enabling and I put that submission orally this morning and I will not take time to repeat it now. As to the question of wastage, can I just say this. First, one has to bear in mind in looking at the section and in looking at the explanatory materials relating to it that when section 177EA was enacted, the shape of the imputation provisions was materially different from what it is now.
One of the material differences was that when section 177EA was enacted those taxpayers who were tax exempt or who had a low tax rate got a credit which was exhausted once the tax they would otherwise pay had been offset. Under the current provisions there is not merely an application to the tax otherwise payable, but also a refund. So that one has to read the explanatory memoranda accordingly in terms of the policy of wastage which was said to be there at the outset.
It is still the case that non‑residents, for example, only get relief to the extent that withholding tax is abated and that a company which has no distributable profits, but has franking credits, is inhibited by the absence of distributable profits from passing the franking credits on, and it is to the latter situation that paragraph (ga) is directed. One sees this in the reasons of the Full Court. Your Honours have been given the reference to this a number of times, but if I may, I will do so again. They are at page 625 in paragraphs 87 to 99 and at page 668 in paragraphs 201 to 207.
Now, the notion that the bank was inhibited from distributing its franking credits is not one that was put at any stage earlier. It was certainly not put at trial, and it was not open at trial. Not all the evidence is reproduced in the Court’s appeal books but at pages 62 to 65 the Court will see the history of the bank’s franking of distributions. One thing that is material to note at page 65 is the enormous disparity between the franking credits which were applied to dividends on ordinary shares and the franking credits which were applied to dividends on the fixed or floating rate preference securities, PERLS II, PERLS III, PERLS IV and PERLS V is referred to briefly on page 66.
The second thing to be said about it is that the dividend policy of the bank, which is manifest from its annual reports, which are not in evidence, but I can tell your Honours this - the bank regularly distributed about 70 to 80 per cent of its annual profit. It retained about 20 to 30 per cent. By June 2009 - and your Honours will see this on page 334 of the appeal book – I will not take your Honours to it – it had about $7.8 billion of retained profits.
That was part of its Tier 1 capital, but it was available for distribution, and it was available for distribution as franked dividends. The bank was not in a position to which paragraph (ga) was directed. It was not a case of unlocking credits which could not otherwise be used, and any argument based on that notion is misdirected entirely.
Your Honours, as to paragraph 1(d), the idea of the lower threshold, your Honour Justice Hayne asked my friend “Whose tax and how is it reduced?” My friend answered, “It is the bank’s tax that was reduced by what happened in New Zealand”. Your Honour Justice Bell asked him “How is the Australian tax reduced by the New Zealand deduction?”, to which question my friend did not give an answer. That is because there is no answer.
Section 23AH, which your Honours will find in the legislation volume, exempts income which is taxed in New Zealand, whether or not a deduction is allowed against that income. The deduction allowed against the income reduced the New Zealand tax, but it had no effect on the operation of section 23AH on the gross income derived from New Zealand.
My learned friend addressed the bank’s position on the subject of purpose but he did not in any way link that position to the purpose of conferring franking credits on the appellant or on other investors. Any change in the cost of funds in New Zealand, any change resulting from a reduction in New Zealand tax simply does not affect the franking, there is no connection and none could be or was offered.
As to paragraph 2(a) of my friend’s outline, your Honour Justice Gageler asked my friend towards the end of his argument what precise benefit to the bank is the New Zealand deduction, and my friend’s answer was they reduced costs of capital. It is not, he said, the New Zealand deduction.
Yet, when one looks at the written submissions and at the case which was put below, it was all about the New Zealand deduction. Now he says it is about the exemption from tax, but the exemption applies to all the gross income derived in New Zealand and there is no connection between that exemption and the capacity for franking and there is no tracing connection in the franking provisions for the reasons given by Justice Edmonds.
My learned friend put a proposition that if a company raised preference shares or ordinary capital in Australia and invested it in New Zealand it will pay New Zealand tax and it will not pay Australian tax. We agree with that, but neither the use of the staple structure nor the obtaining of a deduction in New Zealand, nor the exemption of New Zealand income makes any difference to the ability of the bank to frank distributions.
If my learned friend’s argument were right then it must apply to all preference shares. If my learned friend’s argument about cost of capital is right, it must apply to all preference shares but that is a consequence which my friend adjures. Now, in paragraph 3(a) my friend accuses us of seeking to reintroduce “dominant purpose”. We would respectfully say that is merely an assertion, it is not supported by any analysis. We do not say that the purpose of providing franking credit benefits referred to in paragraph (3)(e) must be dominant.
What we do say is what we put in our reply at paragraphs 4 to 8 of our written reply. I will not read those to your Honours again. But in this connection my friend, several times, described the requirement of the parenthesis as being that the purpose be “merely incidental”. Adding the word “merely” tends to prejudge the issue. The word “merely” is not statutory. Finally, in this regard, your Honour the Chief Justice asked my friend about the relationship between 177A(5) and 177EA(3)(e). We would say that subsection (5) is subject to the express language of the parenthesis in paragraph (e).
As to paragraph 3(b) of my friend’s argument, we do not say that all Tier 1 capital must yield franked dividends. What we do say is that all the capital which the bank was in a position to issue would yield franked dividends. That is really the point of our submission. It is not a point about statutory interpretation or about the juxtaposition of the prudential standards and section 215‑10 it is about the way in which those provisions operated in the bank’s case. It is possible that there are particular forms of notes which qualify as Tier 1, but in the bank’s case they could not be issued as Tier 1 capital.
We do not agree that to characterise the word “incidental” as extending to purposes which are of an ancillary or consequential or following on nature – and all those words are, as my friend conceded, a symphony of syllogisms – they are just ways of trying to illuminate the sense. But we do not say that that characterisation precludes the application of the section either to dividend streaming or to franking credit trading.
There can be schemes in which the purpose of providing franking credit benefits to investors are clearly more than incidental and some of the transactions which are referred to in the explanatory memorandum are clearly of that nature; a purchase come dividend, sale ex‑dividend, receipt in between of a dividend and franking credit. The franking credit in that situation is more than simply consequential or following on naturally. It is clearly a significant purpose of the transaction. It may not be dominant, but it is significant.
Your Honours, as to paragraph 3(d), Justice Edmonds began by saying that this was not a tax avoidance scheme and no doubt he did that because that was the way we opened the case to him. But all he was doing was making the point that this was a regular commercial transaction by a bank regulated by APRA, having to comply with prudential standards and seeking to raise capital. It was a transaction where securities were issued to some 33,000 investors, $2 billion was raised, they were listed on the ASX. That is not redolent of tax avoidance.
As to paragraph 4(a) of my friend’s skeleton, nothing that is said in that paragraph or in my friend’s oral argument today responds to what was said by Justice Edmonds at paragraphs 87 to 99, especially at paragraphs 95 to 96, nor to what was said by Justice Jessup at paragraphs 204 to 207 of his argument. My friend took your Honours to those paragraphs, but apart from saying that Justice Emmett was to be preferred, he did not really explain why the analysis in them was wrong and nothing in it responds to what is said in our submissions in reply at paragraphs 12 and 14.
Your Honour Justice Hayne asked my friend what is proposition two, and with respect, your Honour did not get an answer to that. Your Honour Justice Bell asked “where does the money come from?” The answer which my friend gave was to say it comes from New Zealand. The problem with that answer is that it confuses an equity lawyer’s approach, which traces moneys in the hands of a trustee through to their final destination, with the approach which is to be taken to company distributions, which is not single‑entry bookkeeping, tracing funds through, it is double ‑entry bookkeeping.
The money, wherever it is, represents a fund. The money may come from New Zealand, but the fund comes from the profits of the bank, and the franking credits come from the bank’s franking credit account generated by the payment of Australian tax. It is not a matter of looking at where the cash came from. My friend several times put in this connection the proposition that there was a releasing of franking credits, that there was an untaxed source which was being released to the investors. There was a releasing of franking credits without a corresponding generation of franking credits. About that, two things can be said.
First, it was not put earlier in any way, and it is answered by the materials which I have just taken your Honours to about the way in which the bank franked its distributions, the franking credits which were available to it and the fund of profits which were available to be franked, should the bank decide that that was an appropriate course. But also it provides no answer to the reasoning of Justice Edmonds in the passages I mentioned at paragraphs 87 to 99. Your Honour the Chief Justice remarked that franking credits were a sweetener. That is perhaps a rather more colourful expression than is warranted, if I may say so with respect.
FRENCH CJ: I put a hypothesis about the nature of the submission being put to us.
MR SLATER: Yes. We do not dispute, as I said at the outset, that the bank had a purpose of providing the franking credits to its investors, but we say that that purpose fell within the exception for an incidental purpose.
FRENCH CJ: I think what I was putting to Mr Williams was of trying to characterise an aspect of his argument as involving the proposition that the subscribers were requiring their securities by subscribing capital which was being deployed for uses in New Zealand which generated deductions and that they have a deemed equity based on the subscription of that capital and that their franking credits came from, as it were, tax paid in respect of other capital which had been subscribed.
I was really asking whether he was characterising that use of the franking credits in that circumstance as a kind of – well, I will use the word “incentive” or “sweetener”, it really does not matter. I think the accepted, not so much the characterisation of “sweetener”, it is really this dividing up of the sources of the equities within the company.
MR SLATER: For the reasons which are given by Justice Edmonds, we say that there is no tracing of franking credits to particular sources. It is not the way the legislation works. When you look at Division 205 there is no tracing mechanism provided for and there can be none.
Your Honours, in paragraph 4(b) my friend says that the capped returns reduced the bank’s cost of capital and that was a benefit to the bank. Well, we accept that. That is one of the reasons why the bank issued these securities rather than ordinary shares because it provided a lower cost of capital and a diversification of the bank’s corporate structure. But it does not point to any purpose within paragraph (e) and really, my friend made no attempt to relate the cost of capital advantage to the provisional franking credits.
Finally, your Honours, in relation to paragraph 4(c) “change in financial position” that is section 177D(b)(6), we agree that paragraph (6) is a relevant consideration within subsection (17) and one that is relevant to take into account. But the reason we say it is relevant to take into account is that the change in the bank’s financial position was that it raised Tier 1
capital and that provides the main purpose to which any purpose associated with franking credits was within the meaning of the word “incidental” as we advance it to your Honours, incidental. If your Honours please, those are our submissions.
FRENCH CJ: Yes, thank you, Mr Slater. The Court will reserve its decision. The Court adjourns until 10.15 tomorrow.
AT 3.50 PM THE MATTER WAS ADJOURNED
10
0
0