Noza Holdings Pty Ltd v Commissioner of Taxation
[2011] FCA 46
•4 February 2011
FEDERAL COURT OF AUSTRALIA
Noza Holdings Pty Ltd v Commissioner of Taxation
[2011] FCA 46
Citation: Noza Holdings Pty Ltd v Commissioner of Taxation [2011] FCA 46 Parties: NOZA HOLDINGS PTY LTD (ACN 098 410 881) v COMMISSIONER OF TAXATION File number(s): VID 758 of 2009, VID 759 of 2009,
VID 760 of 2009, VID 761 of 2009,
VID 762 of 2009, VID 763 of 2009Parties: ITW AFC PTY LTD (ACN 091 191 865) v COMMISSIONER OF TAXATION File number: VID 764 of 2009 Parties: CS FINANCING I LLC v COMMISSIONER OF TAXATION File number: VID 908 of 2009 Judge: GORDON J Date of judgment: 4 February 2011 Catchwords: CORPORATIONS – whether declaration of dividend created a debt pursuant to s 254V(2) of the Corporations Act 2001 (Cth) – validity of the declaration of dividend
TAXATION – deductibility of dividends – whether an amount paid by way of endorsement of a promissory note is deductible pursuant to s 25-90 of the Income Tax Assessment Act 1997 (Cth) – whether there were sufficient “accumulated earnings” to pay dividends – whether payment of dividends amounts to derivation of income from a foreign source – whether the income is exempt income pursuant to s 23AJ of the Income Tax Assessment Act 1936 (Cth) – meaning of “debt interest” and “debt deduction” – whether deductible on incurred basis - whether full amount deductible
TAXATION – Part IVA – existence of a tax benefit – whether scheme entered into or carried out for the dominant purpose of obtaining a tax benefit
TAXATION – Penalties – whether penalty should be reduced to nil pursuant to s 284-145 of Schedule 1 to the Taxation Administration Act 1953 (Cth) – whether penalty should be reduced for voluntary disclosure of shortfall amount
TAXATION – withholding tax – whether Part IVA authorised the Commissioner to determine that dividend paid was subject to dividend withholding tax under s 128B of the Income Tax Assessment Act 1936 (Cth)
Legislation: Company Law Review Act 1998 (Cth)
Corporations Act 2001 (Cth)
Income Tax Assessment Act 1936 (Cth)
Income Tax Assessment Act 1997 (Cth)
International Tax Agreements Act 1953 (Cth)New Business Tax System (Debt and Equity) Act 2001 (Cth)
New Business Tax System (Thin Capitalisation) Act 2001 (Cth)
Taxation Administration Act 1953 (Cth)Cases cited: Allstate Life Insurance Co v Australia and New Zealand Banking Group Ltd (No 6) (1996) 64 FCR 79
Archibald Howie Pty Ltd v Commissioner of Stamp Duties (NSW) (1948) 77 CLR 143
Australian National Hotels Ltd v Commissioner of Taxation (1988) 19 FCR 234
BHP Billiton Finance Ltd v Commissioner of Taxation (2009) 72 ATR 746
Bluebottle UK Ltd v Deputy Commissioner of Taxation (2007) 232 CLR 598
Brookton Co-operative Society Ltd v Commissioner of Taxation (1981) 147 CLR 441
CIC Insurance Limited v Bankstown Football Club Limited (1997) 187 CLR 384
Commissioner of Taxation v Sun Alliance Investments Pty Ltd (in liq) (2005) 225 CLR 488
Commissioner of Taxation v Broken Hill Pty Co Ltd (2000) 179 ALR 593
Commissioner of Taxation v Citibank Ltd (1993) 44 FCR 434
Commissioner of Taxation v Citylink Melbourne Limited (2006) 228 CLR 1
Commissioner of Taxation v Condell (2006) 63 ATR 514
Commissioner of Taxation v Consolidated Press Holdings Ltd (2001) 207 CLR 235
Commissioner of Taxation v Consolidated Press Holdings Ltd (No 1) (1999) 91 FCR 524
Commissioner of Taxation v Cooke and Sherden (1980) 29 ALR 202
Commissioner of Taxation v Hart (2004) 217 CLR 216
Commissioner of Taxation v McNeil (2005) 144 FCR 514
Commissioner of Taxation v McNeil (2007) 229 CLR 656
Commissioner of Taxation v Montgomery (1999) 198 CLR 639
Commissioner of Taxation v News Australia Holdings Pty Limited [2010] FCAFC 78
Commissioner of Taxation v Peabody (1994) 181 CLR 359
Commissioner of Taxation v Slater Holdings Limited (1984) 156 CLR 447
Commissioner of Taxation v Spotless Services Ltd (1996) 186 CLR 404
Commissioner of Taxation v Star CityPty Ltd (2009) 175 FCR 39
Commissioner of Taxation v Stone (2005) 222 CLR 289
Commissioner of Taxation v Uther (1965) 112 CLR 630
Comptroller of Stamps (Vic) v Ashwick (Vic) No 4 Pty Ltd (1987) 163 CLR 640
Condell v Commissioner of Taxation (2007) 66 ATR 100
Cooper Brookes (Wollongong) Pty Ltd v Federal Commissioner of Taxation (1981) 147 CLR 297
Coulton v Holcombe (1986) 162 CLR 1
CPH Property Pty Ltd v Federal Commissioner of Taxation (1998) 88 FCR 21
Cridland v Commissioner of Taxation (1977) 140 CLR 330
Eisner v Macomber (1920) 252 US 189
Federal Coke Company Pty Ltd v Federal Commissioner of Taxation (1977) 15 ALR 449
Federal Commissioner of Taxation v Australian Guarantee Corporation Ltd (1984) 2 FCR 483
Federal Commissioner of Taxation v BHP Billiton Finance Ltd (2010) 182 FCR 526
Federal Commissioner of Taxation v Malouf (2009) 174 FCR 581
Federal Commissioner of Taxation v Midland Railway Company of Western Australia (1952) 85 CLR 306
Federal Commissioner of Taxation v Sleight (2004) 136 FCR 211
Federal Commissioner of Taxation v Star City Pty Ltd (No 2) (2009) 180 FCR 448
Federal Commissioner of Taxation v Total Holdings (Australia) Pty Ltd (1979) 43 FLR 217
Harbinger Capital Partners Master Fund I, Ltd v Granite Board Corp 906 A 2d 218 (Del Ch, 2006)
InRe Spanish Prospecting CompanyLtd [1911] 1 Ch 92
Industrial Equity Ltd v Blackburn (1977) 137 CLR 567
Ivanhoe Partners v Newmont Mining Corp 533 A 2d 585 (Del Ch 1987)
Ivanhoe Partners v Newmont Mining Corp 535 A 2d 1334 (Del, 1987)
Macquarie Finance Limited v Commissioner of Taxation (2005) 146 FCR 77
Marra Developments Ltd v BW Rofe Pty Ltd [1977] 2 NSWLR 616
Neilson v Overseas Projects Corporation of Victoria Ltd (2005) 223 CLR 331
North Sydney Brick and Tile Co Ltdv Darvall (1989) 17 NSWLR 327
Noza Holdings Pty Ltd v Federal Commissioner of Taxation [2010] FCA 996
Peabody v Federal Commissioner of Taxation (1993) 40 FCR 531
QBE Insurance Group Ltd v Australian Securities Commission (1992) 38 FCR 270
Re Swan Brewery Co Ltd (1976) 3 ACLR 164
Ronpibon Tin NL v Federal Commissioner of Taxation (1949) 78 CLR 47
Spassked Pty Ltd v Federal Commissioner of Taxation (2003) 136 FCR 441
Spriggs v Commissioner of Taxation (2009) 239 CLR 1
St George Bank Ltd v Federal Commissioner of Taxation (2009) 176 FCR 424
Steele v Deputy Commissioner of Taxation (1999) 197 CLR 459
Weinberg v Baltimore Brick Company 114 A 2d 812 (Del, 1955)
Western Gold Mines (NL) v Commissioner of Taxation (WA) (1938) 59 CLR 729Date of hearing: 6 – 8, 10, 13, 15 – 16 September 2010 Date of last submissions: 1 October 2010 Place: Melbourne Division: GENERAL DIVISION Category: Catchwords Number of paragraphs: 445 Counsel for the Applicants: JW de Wijn QC with SHP Steward SC and DJ McInerney Solicitor for the Applicants: PricewaterhouseCoopers Counsel for the Respondent: MK Moshinsky SC with SJ Sharpley and AM Dinelli Solicitor for the Respondent: Gadens Lawyers
IN THE FEDERAL COURT OF AUSTRALIA
VICTORIA DISTRICT REGISTRY
GENERAL DIVISION
VID 758 of 2009
BETWEEN: NOZA HOLDINGS PTY LTD (ACN 098 410 881)
ApplicantAND: COMMISSIONER OF TAXATION
Respondent
JUDGE:
GORDON J
DATE OF ORDER:
4 February 2011
WHERE MADE:
MELBOURNE
THE COURT ORDERS THAT:
1.The parties bring in orders to give effect to these reasons for decision by 4.00pm on 18 February 2011.
Note:Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.
The text of entered orders can be located using Federal Law Search on the Court’s website.
IN THE FEDERAL COURT OF AUSTRALIA
VICTORIA DISTRICT REGISTRY
GENERAL DIVISION
VID 759 of 2009
BETWEEN: NOZA HOLDINGS PTY LTD (ACN 098 410 881)
ApplicantAND: COMMISSIONER OF TAXATION
Respondent
JUDGE:
GORDON J
DATE OF ORDER:
4 February 2011
WHERE MADE:
MELBOURNE
THE COURT ORDERS THAT:
1.The parties bring in orders to give effect to these reasons for decision by 4.00pm on 18 February 2011.
Note:Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.
The text of entered orders can be located using Federal Law Search on the Court’s website.
IN THE FEDERAL COURT OF AUSTRALIA
VICTORIA DISTRICT REGISTRY
GENERAL DIVISION
VID 760 of 2009
BETWEEN: NOZA HOLDINGS PTY LTD (ACN 098 410 881)
ApplicantAND: COMMISSIONER OF TAXATION
Respondent
JUDGE:
GORDON J
DATE OF ORDER:
4 February 2011
WHERE MADE:
MELBOURNE
THE COURT ORDERS THAT:
1.The parties bring in orders to give effect to these reasons for decision by 4.00pm on 18 February 2011.
Note:Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.
The text of entered orders can be located using Federal Law Search on the Court’s website.
IN THE FEDERAL COURT OF AUSTRALIA
VICTORIA DISTRICT REGISTRY
GENERAL DIVISION
VID 761 of 2009
BETWEEN: NOZA HOLDINGS PTY LTD (ACN 098 410 881)
ApplicantAND: COMMISSIONER OF TAXATION
Respondent
JUDGE:
GORDON J
DATE OF ORDER:
4 February 2011
WHERE MADE:
MELBOURNE
THE COURT ORDERS THAT:
1.The parties bring in orders to give effect to these reasons for decision by 4.00pm on 18 February 2011.
Note:Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.
The text of entered orders can be located using Federal Law Search on the Court’s website.
IN THE FEDERAL COURT OF AUSTRALIA
VICTORIA DISTRICT REGISTRY
GENERAL DIVISION
VID 762 of 2009
BETWEEN: NOZA HOLDINGS PTY LTD (ACN 098 410 881)
ApplicantAND: COMMISSIONER OF TAXATION
Respondent
JUDGE:
GORDON J
DATE OF ORDER:
4 February 2011
WHERE MADE:
MELBOURNE
THE COURT ORDERS THAT:
1.The parties bring in orders to give effect to these reasons for decision by 4.00pm on 18 February 2011.
Note:Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.
The text of entered orders can be located using Federal Law Search on the Court’s website.
IN THE FEDERAL COURT OF AUSTRALIA
VICTORIA DISTRICT REGISTRY
GENERAL DIVISION
VID 763 of 2009
BETWEEN: NOZA HOLDINGS PTY LTD (ACN 098 410 881)
ApplicantAND: COMMISSIONER OF TAXATION
Respondent
JUDGE:
GORDON J
DATE OF ORDER:
4 February 2011
WHERE MADE:
MELBOURNE
THE COURT ORDERS THAT:
1.The parties bring in orders to give effect to these reasons for decision by 4.00pm on 18 February 2011.
Note:Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.
The text of entered orders can be located using Federal Law Search on the Court’s website.
IN THE FEDERAL COURT OF AUSTRALIA
VICTORIA DISTRICT REGISTRY
GENERAL DIVISION
VID 764 of 2009
BETWEEN: ITW AFC PTY LTD (ACN 091 191 865)
ApplicantAND: COMMISSIONER OF TAXATION
Respondent
JUDGE:
GORDON J
DATE OF ORDER:
4 February 2011
WHERE MADE:
MELBOURNE
THE COURT ORDERS THAT:
1.The parties bring in orders to give effect to these reasons for decision by 4.00pm on 18 February 2011.
Note:Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.
The text of entered orders can be located using Federal Law Search on the Court’s website.
IN THE FEDERAL COURT OF AUSTRALIA
VICTORIA DISTRICT REGISTRY
GENERAL DIVISION
VID 908 of 2009
BETWEEN: CS FINANCING I LLC
ApplicantAND: COMMISSIONER OF TAXATION
Respondent
JUDGE:
GORDON J
DATE OF ORDER:
4 February 2011
WHERE MADE:
MELBOURNE
THE COURT ORDERS THAT:
1.The parties bring in orders to give effect to these reasons for decision by 4.00pm on 18 February 2011.
Note:Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.
The text of entered orders can be located using Federal Law Search on the Court’s website.
INDEX TO REASONS FOR JUDGMENT
CONTENT
PARA NOS
A
INTRODUCTION
[1] – [14]
B
FACTS
[15]
(1) Project Siam
[16] – [17]
(2) Early 2001
[18] – [28]
(3) June 2001
[29] – [36]
(4) July – September 2001
[37] – [51]
(5) October 2001
[52] – [89]
(6) November 2001
[90] – [130]
(7) 2002 Year
[131] – [132]
(8) 2003 Year
[133] – [149]
(9) 2004 and 2005 Years
[150]
(10) SGTS Financial Position
[151]
C
LEGAL ISSUES AND ANALYSIS
(1) Deductibility in 2003 for dividend paid: s 25-90
(a) Introduction
[152] – [162]
(b) Summary of Findings
[163] – [166]
(c) Was a Loss or Outgoing Incurred?
[167] – [214]
(i) Alternative 1 – CSA incurred a liability when CSA “declared” the dividend in 2003
[169] – [185]
(ii) Are the applicants entitled to rely upon s 254V of the Corporations Act
[186] – [190]
(iii) Alternative 2 - CSA incurred a liability when CSA “declared and paid” the dividend to CSF in 2003
[191] – [213]
(iv) Conclusion
[214]
(d) Was the Loss or Outgoing Incurred in Deriving Income from a foreign source?
[215] – [230]
(e) Was the Income (ie the Dividends paid by SGTS) “exempt income” under s 23AJ?
[231] – [232]
(f) Was the loss or Outgoing a Cost in relation to a “Debt Interest”?
[233] – [254]
(g) Conclusion
[255] – [256]
(2) Deductibility for dividend on incurred basis
[257] – [272]
(3) Pt IVA
(a) Introduction and Summary of Findings
[273] – [275]
(b) Scheme
[276] – [279]
(c) Tax benefit
[280] – [292]
(d) Application of s 177D(b) of the 1936 Act – Dominant Purpose
[293] – [376]
(4) Penalties
[377] – [390]
(5) Withholding tax and Pt IVA
[391]
(a) Facts
[392] – [399]
(b) Withholding tax provisions
[400] – [409]
(c) Pt IVA
[410]
(i) Scheme
[411] – [412]
(ii) Tax benefit
[413] – [424]
(iii) Dominant purpose
[425] – [444]
D
CONCLUSION AND ORDERS
[445]
ABBREVIATIONS USED IN THESE REASONS FOR JUDGMENT
Abbreviation
Name / Entity etc
1936 Act
means the Income Tax Assessment Act 1936 (Cth).
1997 Act
means the Income Tax Assessment Act 1997 (Cth).
2002 Year
means the year ended 30 November 2002 (in lieu of the year of income ended 30 June 2002).
2003 Year
means the year ended 30 November 2003 (in lieu of the year of income ended 30 June 2003).
2004 Year
means the year ended 30 November 2004 (in lieu of the year of income ended 30 June 2004).
AFC
means ITW AFC Pty Ltd (ACN 091 191 865), a company incorporated in Australia, an Australian resident company, a member of the ITW Group being a wholly owned subsidiary of CSA, treated as a branch of CSF for US tax purposes and the Applicant in VID 764 of 2009. AFC was also the holding company for SGTS, a Delaware company.
AFC Preference Shares
means the redeemable preference shares issued by AFC to CSA on 15 November 2001.
Azon
means Azon Ltd, an Australian public listed company acquired by ITW Holdings Pty Ltd (an Australian company in the ITW Group) in 1996.
BILCME
means BILCME LLC, a US resident Delaware company that is a wholly-owned subsidiary of Miller.
Chin
means Adrian Chin, a partner at Andersen Legal in Melbourne, who was responsible for the legal drafting of the Australian documentation.
CSA
means CS (Australia) Pty Ltd, a company incorporated in Australia, a wholly-owned subsidiary of CSF and treated as a branch of CSF for US tax purposes.
CSA Preference Shares
means the redeemable preference shares issued by CSA to CSF on 15 November 2001.
CSC
means CS Capital I LLC, a US resident Delaware company that is a subsidiary of ITW PMI Inc.
CSF
means CS Financing I LLC, a US resident Delaware company that is a wholly owned subsidiary of CSC and the Applicant in VID 908 of 2009.
Commissioner
means the Commissioner of Taxation, the Respondent in the Proceedings.
Company Law Review Act
means the Company Law Review Act 1998 (Cth).
Corporations Act
means the Corporations Act 2001 (Cth).
DGCL
means the Delaware General Corporations Law.
Diskin
means Zorach Diskin, a principal of Arthur Andersen in Australia.
Foster
means Monica Foster, employed by Arthur Andersen in the United States and one of ITW’s auditors.
Frishman
means Leigh Frishman, an employee solicitor at Mayer Brown, a United States law firm, who was responsible for the legal drafting of the United States documentation.
GAAP
means the Generally Accepted Accounting Principles.
Holdings Inc
means ITW International Holdings Inc, a US resident Delaware company that is a subsidiary of Investments Inc.
ICBIL
means ICBIL LLC, a US resident Delaware company that is a wholly-owned subsidiary of ITW Inc.
International Tax Agreements Act
means the International Tax Agreements Act 1953 (Cth).
IDR
means the Illinois Department of Revenue.
Investments Inc
means ITW Investments Inc, a US resident Delaware company that is a wholly owned subsidiary of ITW Inc.
ITW Inc
means Illinois Tool Works Inc, a US resident Delaware company listed on the New York Stock Exchange.
ITW Group
means the group of companies of which ITW Inc was the head company.
ITW PMI
means ITW PMI International Investments Inc, a US resident Delaware company that is a subsidiary of Holdings Inc.
Janetzki
means Peter Janetzki, of Arthur Andersen in Melbourne.
Kropp
means Ronald David Kropp, ITW’s Director of Corporate Accounting.
Lieberman
means Rich Lieberman, a Deloitte partner in Chicago specialising in United States state income tax.
Levy
means William Levy, a Chicago partner at Mayer Brown, a United States law firm engaged by ITW to provide United States federal tax advice.
Martec
means Martec Pty Ltd, an Australian resident company that is an indirect wholly-owned subsidiary of ITW Inc.
Miller
means Miller Electric Manufacturing Co, a US resident Wisconsin company that is an indirect wholly-owned subsidiary of ITW Inc.
MNAT
means Morris, Nichols, Arsht & Tunnell, a United States law firm.
Murtaugh
means Kathleen Ann Murtaugh, an ITW employee who reported to Sutherland.
Noza
means Noza Holdings Pty Ltd (ACN 098 410 881), a company incorporated in Australia, an Australian resident company, a member of the ITW Group and the Applicant in VID 758-763 of 2009. Noza’s immediate holding company was ITW (EU) Holdings Ltd and its ultimate holding company was ITW. At the commencement of the 2003 Year (namely, 1 December 2002), Noza became the head company of the Noza MEC Group.
Noza MEC Group
the Multiple Entry Consolidated (MEC) group pursuant to Div 719 of Part 3-90 of the 1997 Act which from 1 December 2002 had Noza as the head company and included AFC and CSA.
Private Letter Ruling
means the private letter ruling issued by the IDR on 15 September 2001.
Rodriguez
means Felix Rodriguez, ITW’s Treasurer in late 2001.
SGTS
means Solutions Group Transaction Subsidiary Inc, a US resident Delaware company that is a wholly-owned subsidiary of AFC.
SGTS Preferred Stock
means the preferred stock issued by SGTS to AFC on 15 November 2001.
Siddons
means Siddons Ramset Ltd, an Australian public listed company acquired by the ITW Group in 2000.
Sutherland
means Allan Cameron Sutherland, the Senior Vice President of ITW Inc. In 2001, Sutherland was responsible for the “Leasing and Investments” segment, including the Capital Solutions Group.
TAA
means the Taxation Administration Act 1953 (Cth).
Underwood
means Mike Underwood, employed by Arthur Andersen in the United States and one of ITW’s auditors.
US
means the United States of America.
Wills
means David Wills, a partner of Arthur Andersen in Melbourne.
WHT EM
means the Explanatory Memorandum to the Taxation Laws Amendment Bill (No 2) 1997.
IN THE FEDERAL COURT OF AUSTRALIA
VICTORIA DISTRICT REGISTRY
GENERAL DIVISION
VID 758 of 2009
VID 759 of 2009
VID 760 of 2009
VID 761 of 2009
VID 762 of 2009
VID 763 of 2009
BETWEEN: NOZA HOLDINGS PTY LTD (ACN 098 410 881)
ApplicantAND: COMMISSIONER OF TAXATION
Respondent
IN THE FEDERAL COURT OF AUSTRALIA
VICTORIA DISTRICT REGISTRY
GENERAL DIVISION
VID 764 of 2009
BETWEEN: ITW AFC PTY LTD (ACN 091 191 865)
ApplicantAND: COMMISSIONER OF TAXATION
Respondent
IN THE FEDERAL COURT OF AUSTRALIA
VICTORIA DISTRICT REGISTRY
GENERAL DIVISION
VID 908 of 2009
BETWEEN: cs FINANCING I LLC
ApplicantAND: COMMISSIONER OF TAXATION
Respondent
JUDGE:
GORDON J
DATE:
4 February 2011
PLACE:
MELBOURNE
REASONS FOR JUDGMENT
A. INTRODUCTION
ITW Inc was and remains a US company listed on the New York Stock Exchange with its head office in Glenview, Illinois. In 2001, ITW Inc and its wholly owned subsidiaries (collectively the ITW Group), operated some 600 decentralised businesses in over 40 countries, principally concerned with the manufacture and sale of a wide range of consumer and industrial products. At that time, the ITW Group’s annual revenues exceeded US$9 billion, approximately two thirds of which was derived from the ITW Group’s US operations.
In 2001, the ITW Group held more than 17,000 patents and pending patent applications worldwide and adopted a practice of working closely with its customers to understand and meet their needs (defined as customer-based intangibles). It was said that these two aspects of the ITW Group’s work were the basis for its success.
Customer-based intangibles are a form of intellectual property owned by the ITW Group comprised of confidential customer information and trade secrets relating to ITW Group’s customers. Such information is not able to be protected by patents or other statutory measures. To legally protect this information, the ITW Group considered that it was important to properly catalogue the information and ascribe a value to it so that the ITW Group would be able to seek damages from any employee that misused such information, thereby protecting the information in terrorem.
In 1999, and again in 2001, the ITW Group entered into a series of transactions designed to centralise ownership of its customer-based intangibles and crystallise their value, thereby facilitating any future legal action for their protection as well as giving rise to state tax savings in the US. The first series of transactions in 1999 was known as Project Siam. The second series in 2001 (which involved companies in Australia) became known as “Project Gemini”. These proceedings concern the Australian taxation consequences of transactions entered into as part of Project Gemini. A flowchart of the series of transactions which comprised Project Gemini is attached as Annexure A to these reasons for decision. As the chart reflects, the transactions occurred in three phases – 15 June, 15 October and 15 November 2001.
The issues in these proceedings are complex. They involve the application, inter alia, of the consolidation regime principally contained in Pt 3-90 of the 1997 Act, the debt / equity provisions in Div 974 of the 1997 Act and Pt IVA of the 1936 Act, as well as the law of Delaware (and, in particular, the DGCL), to transactions entered into both here and overseas as part of Project Gemini. To put these issues into some context, it is necessary to restate some principles which underpin the consolidation regime.
Effective 1 July 2002, Australia introduced a consolidation regime to allow a wholly owned group of resident entities to consolidate their tax position rather than be treated as separate entities. The starting point in considering the consolidation regime is Pt 3-90 of the 1997 Act. Section 700-1 provides:
This Part allows certain groups of entities to be treated as single entities for income tax purposes.
Following a choice to consolidate, subsidiary members are treated as part of the head company of the group rather than as separate income tax identities. The head company inherits their income tax history when they become subsidiary members of the group. On ceasing to be subsidiary members, they take with them an income tax history that recognises that they are different from when they became subsidiary members.
This is supported by rules that:
(a)set the cost for income tax purposes of assets that subsidiary members bring into the group; and
(b)determine the income tax history that is taken into account when entities become, or cease to be, subsidiary members of the group; and
(c)deal with the transfer of tax attributes such as losses and franking credits to the head company when entities become subsidiary members of the group.
(Emphasis added.)
Section 700-5 of the 1997 Act provides an overview of the regime and provides, so far as is relevant:
(1)The single entity rule determines how the income tax liability of a consolidated group will be ascertained. The basic principle is contained in the Core Rules in Division 701.
(2)Essentially, a consolidated group consists of an Australian resident head company and all of its Australian resident wholly-owned subsidiaries (which may be companies, trusts or partnerships). ...
(3)An eligible wholly-owned group becomes a consolidated group after notice of a choice to consolidate is given to the Commissioner.
(4) This Part also contains rules which set the cost for income tax purposes of assets of entities when they become subsidiary members of a consolidated group and of membership interests in those entities when they cease to be subsidiary members of the group.
(5)Certain tax attributes (such as losses and franking credits) of entities that become subsidiary members of a consolidated group are transferred under this Part to the head company of the group. These tax attributes remain with the group after an entity ceases to be a subsidiary member.
(Emphasis added.)
The decision to consolidate is optional: s 700-5(3). However, if a group decides to consolidate, all of its wholly owned Australian resident companies must consolidate: s 700-5(2). A “consolidated group” consists of a “head company” and all its “subsidiary members”: see also ss 703-5(3), 703-15 and 703-20 of the 1997 Act. A “head company” is a resident company: ss 703-10 and 703-15. Consolidation is permissible between resident subsidiaries of a foreign parent even though there is no single head company resident in Australia through what is described as a Multiple Entry Consolidated (MEC) Group. A MEC Group is treated in the same way as a consolidated group with all members of the group treated as parts of the head company for Australian tax purposes.
The Core Rules are in Div 701 of Pt 3-90 of the 1997 Act: ss 701-1 to 701-30. The most important is the “single entity rule”: s 701-1. In general terms, subsidiary members of the group are treated as parts of the head company, rather than separate entities. They are treated as one single taxpayer. This has important implications. Any transactions between members of the group will be ignored for tax purposes. For example, the assets and available tax losses of the subsidiary members of the group automatically become those of the head company – they are attributed to the head company.
In proceedings numbered VID 758-764 of 2009, the taxpayers (AFC and Noza) were Australian resident companies who were members of the ITW Group. AFC was incorporated in Australia and was a wholly owned subsidiary of CSA (also an Australian company). Noza was also incorporated in Australia. Its ultimate holding company was ITW Inc. At the commencement of the 2003 year (1 December 2002), Noza became the head company of a MEC Group pursuant to Div 719 of Pt 3-90 of the 1997 Act. The MEC Group included AFC and CSA. Accordingly, in these proceedings, the relevant taxpayer in the 2002 year was AFC and from 2003 to 2005 the relevant taxpayer was Noza in its capacity as head company of the MEC Group. In proceedings numbered VID 908 of 2009, the relevant taxpayer is CSF, a Delaware limited liability company resident in the US which is a member of the ITW Group and the holding company for CSA.
The various Pt IVC proceedings are therefore concerned with the following taxpayers and issues:
Proceeding
Taxpayer
Issue
Income Year
764/2009 AFC Deductions under s 25-90 and Pt IVA 2002 758/2009 Noza Deductions under s 25-90 and Pt IVA 2003 759/2009 Noza Deductions under s 25-90 and Pt IVA 2004 760/2009 Noza Carried forward losses 2004 761/2009 Noza Deductions under s 25-90 and Pt IVA 2005 762/2009 Noza Carried forward losses 2005 763/2009 Noza Penalties 2003 to 2005 908/2009 CSF Pt IVA 2003
The issues that are to be determined in these proceedings concern transactions which it will be necessary to describe in much greater detail. They concern the consequences of transactions between Australian subsidiaries of the ITW Group (CSA and AFC) and US subsidiaries of the ITW Group (CSF and SGTS). They arise out of, or are associated with, a transfer of royalty rights in 2001 from CSF to AFC. They concern the payment (by the issuing of a promissory note) of dividends on preferred stock issued by another company in the ITW Group (SGTS) to AFC, the payment of dividends on preference shares issued by AFC to CSA by the endorsement of the promissory note to CSA and the payment of dividends on preference shares issued by CSA to CSF by the endorsement of the same promissory note to CSF.
Against that background, the questions for determination in these proceedings are:
1.Whether Noza, as head company of the Noza MEC Group, is entitled to a deduction for all or part of the dividends of $222,655,981 declared and further or alternatively, declared and paid by CSA to CSF (by way of endorsement of a promissory note) in the 2003 income year pursuant to s 25-90 of the 1997 Act.
2.Alternatively to (1):
2.1whether AFC is entitled to a deduction on an incurred basis pursuant to s 25-90 for the amounts that accrued as liabilities owing to CSA (having regard to the terms of the AFC Preference Shares) in the 2002 year being $108,837,942 for dividends and $207,504 for default dividends; and
2.2whether Noza, as head company of a consolidated group for the purpose of Pt 3-90 of the 1997 Act, is entitled to a deduction on an incurred basis pursuant to s 25-90 for the amounts that accrued as liabilities owing by CSA and AFC (having regard to the terms of the AFC and CSA Preference Shares) in each of the 2003, 2004 and 2005 years, being:
2.2.1$108,837,942 for dividends and $4,772,593 for default dividends, totalling $113,610,535 in the 2003 year;
2.2.2$108,837,942 for dividends and $207,504 for default dividends, totalling $109,045,446 in the 2004 year; and
2.2.3$108,837,942 for dividends and $4,772,593 for default dividends, totalling $113,818,039 in the 2005 year.
3.Whether Pt IVA of the 1936 Act applies so as to enable the Commissioner to disallow the deductions otherwise allowable to AFC and / or Noza, howsoever allowed.
4.Whether Noza, AFC and CSF are entitled to a reduction in administrative penalty applied by the Commissioner.
5.Whether Pt IVA of the 1936 Act applies so as to enable the Commissioner to determine that a dividend paid by CSA to CSF (of $222,655,981) in the 2003 year is subject to withholding tax under s 128B of the 1936 Act.
For the detailed reasons below, the answers are:
1.Yes, in part. Noza, as head company of the Noza MEC Group, is entitled to a deduction of $170,983,354, being part of the dividends of $222,655,981 declared and paid by CSA to CSF in the 2003 income year pursuant to s 25-90 of the 1997 Act.The entitlement to deduction for only part of the “dividend” reflects the conclusion that the difference between the expected market yield for the CSA Preference Shares (of 4.5757%) and the dividend rate of 6% was not “interest, the amount in the nature of interest, or any other amount that is calculated by reference to the time value of money” under s 820-40(1)(a) of the 1997 Act but was a return of capital. The Commissioner already allowed a deduction of A$4,980,097 in the 2003 for interest on the unpaid dividends due in the 2002 year;
2.Alternatively to 1, yes. AFC in the 2002 year and Noza in each of the 2003 – 2005 years is entitled to a deduction pursuant to s 25-90 of the 1997 Act for the amounts that accrued as liabilities owing under the terms of Preference Shares limited to that part of the “dividend” which did not comprise a return of capital;
3.No. Part IVA does not apply;
4.No. Noza and AFC are not entitled to a reduction in administrative penalty applied by the Commissioner in relation to that part of the dividend disallowed. The remainder of the issues concerning penalties do not arise; and
5.No. Part IVA does not apply in relation to CSF and the withholding tax issue.
B. FACTS
A number of events occurred in Chicago in the US, in Melbourne, Australia and sometimes in both places. For consistency, I have used the time in Melbourne and, where relevant, listed the time in Chicago in brackets.
(1) PROJECT SIAM
Just prior to the end of the 1999, Sutherland from the ITW Inc’s Leasing and Investments department, in conjunction with ITW Inc’s US advisers and Patent Legal department, initiated Project Siam. Project Siam involved a number of key steps:
1.the perpetual licence of all of ITW Inc’s customer-based intangibles as at that time to a special purpose subsidiary called CBIL Inc (in late 2000 and early 2001, this aspect of Project Siam was revised so that the licence granted by ITW Inc would cover future, as well as existing, customer-based intangibles); and
2.the sub-license of those intangibles back to ITW Inc for a two year period.
As noted earlier (see [4] above), by undertaking these two steps, ITW Inc asserted it had centralised ownership of its customer-based intangibles and crystallised their value, thereby facilitating any future legal action for their protection. In addition, Project Siam gave rise to state tax savings in the US as ITW Inc was able to claim deductions for the royalty payments it made on the sub-license granted by CBIL Inc, as well as interest deductions that arose in connection with the transactions.
(2) EARLY 2001
Early in 2001, the ITW Group commenced investigating other ways in which it could improve protection of the customer-based intangibles of ITW Inc and Miller (a wholly owned subsidiary of ITW Inc) and reduce its US state tax obligations. A common method for reducing US state taxes was to make intra-group payments from high taxing US states to low taxing US states where the payment would be deductible in the high-taxing state and assessable in the low-taxing state.
As a part of this project, the ITW Group decided to migrate its customer-based intangibles from high-taxing states (including Illinois) to a low-taxing state (namely, Delaware). The plan involved the licensing of customer-based intangibles by ITW Inc and Miller to two Delaware ITW Group resident subsidiaries which would then sub-license the intangibles back to ITW Inc and Miller in exchange for the payment of royalties. During the latter part of 2001, the plan was amended, inter alia, to address technical issues as they arose. (By 2 November 2001, the annual state tax savings expected to arise from the transactions was US$16.2 million in gross terms and US$10.5 million net of US federal taxes, totalling US$243 million in gross terms and US$157.5 million net of US federal taxes.)
Also in early 2001, the ITW Group received preliminary advice from its Australian advisers (the tax division of Arthur Andersen (Andersen Tax)) about the introduction of the Australian consolidation regime. An important element of the new consolidation regime for the ITW Group was the proposed allocation of cost base, whereby the cost base of a company acquired by the ITW Group would be allocated to (or “pushed down” to) the assets owned by that company. Therefore, if or when the consolidated group sold assets to a third party, the consolidated group would be subject to capital gains tax calculated by reference to the gain above the assets’ allocated cost base rather than the historical cost base recorded in the assets of the vendor company.
Meetings were held between 28 February and 2 March 2001 attended by Sutherland, other ITW Group employees, representatives of Andersen Tax (including Wills, Janetzki and Diskin) and representatives of KPMG Consulting in relation to the introduction of the consolidation regime and the migration of the ITW Group’s customer-based intangibles.
At those meetings dealing with the proposed consolidation regime, Andersen Tax raised with Sutherland a concern that the proposed consolidations legislation may include an anti-avoidance provision which would restrict the ability to reset the cost base in respect of assets of subsidiaries where there had been a previous “sister to sister” rollover. As Sutherland explained it:
… Arthur Andersen’s concern was that the Australian [consolidation] regime was expected to include a measure to prevent the market value of assets transferred from a parent to a subsidiary being pushed down to the subsidiary’s assets where the parent had claimed rollover relief under the capital gains tax rules. In fact, the draft legislation for the consolidation regime contemplated that the subsidiary would be obliged to use, as the cost base of such rolled over assets, the historical cost base of the assets (less depreciation) recorded in the accounts of the parent.
The relevant provision was contained in the Exposure Draft, New Business Tax System (Consolidation) Bill 2000, released on 8 December 2000.
Andersen Tax’s concern was that such a provision in the consolidation regime would cause the cost base that would otherwise be allocated to intellectual property assets held by two Australian subsidiaries of ITW Inc, Martec and AFC, to be reduced to the historical cost base of the assets recorded in the accounts of two Australian publicly listed companies that had been acquired by the ITW Group in 1996 and 2000, Azon or Siddons respectively. This represented a value substantially below the market value of those assets which the ITW Group had paid to acquire them. The “sister to sister” rollover transactions at the time of these acquisitions were said to be worth approximately $200 million. As will become apparent later in these reasons for decision, the Commissioner placed considerable emphasis on this issue at trial in the context of Pt IVA: see [123], [124] and [326] to [340] below. The Commissioner submitted that although this was one of the reasons offered by the ITW Group to the IDR in the private letter ruling request for the offshore transactions in Australia (which formed part of Project Gemini), when faced with a foreign exchange accounting issue which arose at the end of October 2001, it was not one of the risks taken into account despite its significance earlier in the same year. It will be necessary to return to consider this aspect later in these reasons for decision.
In May 2001, the ITW Group decided to restructure its Australian subsidiaries in anticipation of the introduction of the Australian consolidation regime and, at the same time, to combine that restructure with ITW Inc’s US customer-based intangible planning. This is what became known as Project Gemini.
As noted earlier (see [4] above and Annexure A), Project Gemini had three phases. The first phase was the transfer of the shares held in ITW Inc’s Australian operating companies to a single Australian holding company – a restructure of the Australian group in anticipation of the consolidation regime. The second phase was to transfer all intellectual property owned by companies in the Australian group to a single Australian company in the group – AFC. The third phase involved the transfer of the royalty rights that were to be created under the revised Project Siam to AFC.
The implementation of the third phase was intended to result in two outcomes:
1.a proportion of the US$4 billion cost base of the royalty rights would be included for consolidation purposes in AFC’s allocable cost base and was expected to be available to be allocated to other assets held by AFC. (This was expected to result in AFC’s intellectual property assets being allocated a cost base that was relatively close to their market value, even if a “sister to sister” anti-avoidance rollover rule was introduced retrospectively); and
2.by integrating the Australian consolidations restructure with the revised Project Siam planning, ITW Inc could approach the IDR for a private letter ruling which included a significant non-Illinois state tax element to the transactions, namely the Australian steps and the taxation consequences flowing from them. (What in fact occurred, as a matter of substance, was that Project Gemini included steps which injected capital into the Australian group to partly fund the purchase of the royalty rights and for that capital then to be allocated to the tax cost setting amount of all of the intellectual property assets owned by AFC and Martec if the anti-avoidance provision foreshadowed by Andersen Tax was introduced on a retrospective basis).
A team was established by ITW Inc to execute Project Gemini. The team included:
1.Murtaugh, Cyndi Lafuente and Lauri Ink, ITW Inc employees based in ITW Inc’s head office. They were supervised by Sutherland;
2.Lieberman, a Deloitte partner in Chicago specialising in US state income tax;
3.Levy, a Chicago partner at Mayer Brown, a US law firm engaged by ITW Inc to provide US federal tax advice and Frishman, an employee solicitor at Mayer Brown, who was responsible for the legal drafting of the US documentation;
4.Wills, an Andersen Tax partner in Melbourne and Janetzki of Andersen Tax in Melbourne, retained to provide Australian taxation advice; and
5.Chin, a partner at Andersen Legal in Melbourne, who was responsible for the legal drafting of the Australian documentation.
Sutherland’s evidence was that, from inception and subject to the cost base concerns arising from the introduction of the consolidation regime, Project Gemini was intended to allow the income produced from the royalty rights to pass through the Australian ITW Group companies without giving rise to any saving of income tax in Australia and without the US income becoming subject to Australian income or withholding tax. That is, the transfer of royalty rights to Australia was to be tax neutral (save for the possible consolidation cost base effect).
(3) JUNE 2001
In early June, Sutherland revised aspects of Project Gemini. On 6 June 2001, Sutherland sent an email to Murtaugh and some of the ITW Group’s advisers including Levy and Wills setting out in summary form a revised proposal for the steps for the transfer of the royalty rights to Australia. The steps were:
1.ITW PMI would contribute a demand note of A$1 billion to the capital of CSA;
2.CSA would contribute that note to the capital of AFC;
3.AFC would acquire the Miller royalty rights from BILCME in exchange for the A$1 billion note and acquire the ITW royalty rights from ICBIL in exchange for AFC’s own promissory note;
4.AFC would contribute the royalty rights and its note to a new company in Australia; and
5.the new company would in turn contribute the rights and the note to SGTS, a newly established Delaware resident subsidiary of AFC, in exchange for shares.
(The step involving the “intermediate” company between AFC and SGTS was ultimately removed).
On 13 June 2001, Janetzki, Sutherland and Wills held a conference call. The topic of discussion was the proposed transaction in [29(3)] above. An email from Janetzki to Sutherland (copied to Wills) summarising the meeting records that an alternative plan, which involved the royalty rights being held by a United Kingdom company before being transferred to SGTS, was being considered. Sutherland’s evidence was that the alternative plan was not pursued for United Kingdom tax reasons.
On 15 June 2001, the first phase of transactions of Project Gemini, labelled “15 June” on the flowchart at Annexure A, were completed whereby:
1.ITW Inc granted the license for the use of ITW Inc’s customer-based intangibles to ICBIL for a term of 20 years in consideration for 100% membership interests in ICBIL. In turn, ICBIL sub-licensed the intangibles back to ITW Inc to use the customer-based intangibles for a term of 15 years in consideration for the right to payment of royalties equal to 10% of ITW Inc’s “net sale price” for the entire term of 15 years. (The “net sale price” was defined as “the price in ITW Inc’s invoices to distributors and customers, less sales tax required by law to be paid by ITW Inc, credit extended by ITW Inc for Intangible Property to Customer Relationship Services accepted and written off or otherwise credited as returns or sales commissions paid by ITW Inc to independent distributors and import duties”.);
2.Miller granted the license for the use of Miller’s customer-based intangibles to BILCME for a term of 20 years in consideration for 100% of BILCME shares. In turn, BILCME sub-licensed the intangibles back to Miller to use the customer-based intangibles for a term of 15 years in consideration for the payment of royalties equal to 11% of its “net sale price” for the entire term of 15 years;
3.The right to receive the royalty income (the royalty streams) was then transferred to Investments Inc by ICBIL and BILCME, each under a license receivable purchase agreement, whereby Investments Inc acquired the right to receive the royalty streams under the relevant sub-licenses (in (1) and (2) above) for their current market value, satisfied by US$4 billion worth of preferred stock in Investments Inc; and
4.The royalty streams were then contributed by Investments Inc to the capital surplus of Holdings Inc and, then, in turn, by Holdings Inc to ITW PMI.
From 26 to 29 June 2001, Sutherland (and another ITW Group employee) met Wills, Diskin and Janetzki at Arthur Andersen’s offices in Sydney to discuss, inter alia, Phases 2 and 3 of Project Gemini. Options “A” and “B” for the subsequent transfer of the royalty rights involving Australian companies in the ITW Group were discussed. Option B (which was not pursued) involved the United Kingdom companies. At that time, Option A involved a transfer of the royalty rights through Australia and involved the following steps as recorded in a “Summary of Meetings” document:
1.[ITW PMI] transfers a US denominated Demand Note (of say US$750 million) to [CSA] in exchange for an issue of shares. This Demand Note is then transferred from CSA to [AFC] in exchange for the issue of shares.
2.AFC would then use the [ITW PMI] Demand Note and its own “purchase money note” debt obligation (of say US$2,250 million) to acquire the royalty rights from [ITW PMI] for their market value of US$3 billion.
3.Concurrently with this process, AFC would establish / incorporate a new wholly owned US subsidiary, … SGTS … with nominal consideration.
4.Subsequently, the royalty rights and the purchase money note debt obligation would be transferred from AFC to SGTS. In return, SGTS would issue an equity interest (with a market value in this example of US$750 million) to AFC. This equity interest would be in the form of preference shares …
5.Other companies in the US ITW group would contribute non-Australian assets to SGTS in exchange for shares. This would dilute AFC’s ownership interest in SGTS.
6.SGTS would receive the royalty income from ITW Inc in respect of the royalty rights. This income would be used to service the purchase money note debt obligation to [ITW PMI]. The excess would be repatriated to AFC as a dividend in respect of the preference shares. These dividends would subsequently be flowed through AFC and CSA to [ITW PMI – the US group].
7.At some time later, the SGTS preference shares [Preferred Stock] would be redeemed for their face value.
(Emphasis added.)
Option A was developed further over time and ultimately became the transactions implemented on 15 November 2001, being the transactions from CSF through to SGTS shown on Annexure A.
Some of the taxation issues associated with Option A (as well as Option B) were explained by Wills, Diskin and Janetzki. The “Summary of Meetings” recorded the tax explanation in relation to aspects of Option A in the following terms:
…
·We discussed the repatriation of profits from SGTS to AFC. In this regard, “dividends” received by AFC from SGTS will be exempt from Australian tax, provided that AFC has a voting interest in SGTS of at least 10%. However, in order for this exemption to be available, any relevant dividend payments cannot be debited against the share capital account of SGTS.
·As the cash generated by SGTS is likely to exceed the available accounting profits (by virtue of the fact that SGTS will be entitled to an amortisation deduction in respect of the royalty rights in the US), it would be necessary to ensure that AFC receives the preferential dividend payments. For this reason, it was determined that SGTS would issue preference shares to AFC in exchange for the contribution of the royalty rights. In this regard, [Sutherland] advised that the preference should be cumulative and redeemable, but contingent upon sufficient profits being derived by SGTS. As I noted, in order to claim the foreign dividend exemption, it would be necessary for AFC to have a voting interest in SGTS of at least 10% at all times.
·In addition, [Wills] and [Janetzki] noted that it would be necessary to review the new debt / equity rules that were introduced into Parliament on 28 June 2001. As these rules prescribed certain tax consequences for quasi debt and equity instruments, it will be necessary to ensure that the foreign dividend exemption in respect of dividends paid by SGTS on the preference shares continues to be available under this regime.
…
(Emphasis added.)
The advice was reiterated in a draft Discussion Paper prepared by Janetzki on 12 July 2001.
As is apparent, at that stage, the plan was that as SGTS derived sufficient profits it would pay dividends to AFC that would be exempt from Australian tax under s 23AJ of the 1936 Act. Section 23AJ was not mentioned in the “Summary of Meetings” document but it was common ground that that was what was intended. In cross-examination, Sutherland’s evidence was that he understood that if Option A was adopted, it would involve dividends flowing from SGTS to AFC qualifying for exemption under s 23AJ of the 1936 Act (even though s 23AJ itself was not explicitly mentioned). Wills’ evidence was to a similar effect. Wills’ further evidence was that the dividends needed to be exempt under s 23AJ of the 1936 Act to ensure the tax neutrality of the Project Gemini dividend flow into and out of Australia. The substance of the advice from Andersen Tax was that any dividends paid by SGTS to AFC would need to come out of accounting profits in order for the dividend exemption to apply. This advice (accepted by Sutherland) did not change right up to the execution of the Certificate of Designation for the SGTS Preferred Stock.The Commissioner submitted that it was to be inferred that the requirement that dividends be paid only out of “accounting profits” or “accumulated earnings” was inserted to give effect to Andersen Tax’s advice as no contrary evidence was led seeking to explain the development or purpose of the provision in SGTS’ Certificate of Designation for the SGTS Preferred Stock.
Sutherland’s evidence was that it was more appropriate for SGTS to issue preferred stock to AFC rather than ordinary shares because:
1.the preferred stock would be treated as debt for US federal and state income tax purposes and that would allow SGTS to claim a larger tax deduction for “interest” (in the form of dividends) paid on that preferred stock; and
2.AFC’s rights under the preferred stock would ensure AFC earned a share of the SGTS’ profits in priority to any other potential shareholders of SGTS.
As Sutherland explained in a memorandum he sent to Murtaugh and other ITW Inc employees on 29 June 2001, “[i]f all goes well, then the preferred stock will be viewed as equity for Australian tax purposes and debt for US tax purposes …”.
At the meetings on 26 to 29 June 2001 and in the subsequent draft Discussion Paper, Andersen Tax also advised ITW Inc on the withholding tax implications of the proposed structure, including the on-payment of dividends by CSA to its US parent. The substance of the advice was that it should be possible to manage the on-payment of dividends by CSA to its US parent without generating a significant Australian withholding tax cost, by utilising the “foreign dividend account” provisions. The foreign dividend account provisions were enacted in 1994 by the Taxation Laws Amendment Act (No 3) 1994 (Cth) as Subdiv B in Div 11A of Pt III of the 1936 Act. The measures were repealed in 2005 by the Tax Laws Amendment (Loss Recoupment Rules and Other Measures) Bill 2005. The foreign dividend account rules allowed Australian companies that received foreign dividends (in the present case, those exempt under s 23AJ of the 1936 Act) to pay dividends to foreign shareholders without incurring a liability to pay withholding tax. The absence of a withholding tax cost on the payment of the dividends was important because ITW Inc’s principal concern (at that time) was that the arrangement be “tax neutral”.
(4) JULY – SEPTEMBER 2001
It is against that background that on 18 July 2001, ITW Inc representatives (including Sutherland and Murtaugh) and Lieberman of Deloitte met with the IDR in relation to a private letter ruling to be requested by the ITW Group. The ITW Group were seeking the private letter ruling because, at that time, it was proposed that ITW PMI would transfer the royalty rights for their fair market value of US$4 billion. That transfer would give rise to a US$4 billion gain which ITW Inc and its officers were concerned would be taxable in the state of Illinois. The purpose for transferring the royalty rights in consideration for their market value was stated to be to permit the transferee (ITW PMI) to claim amortisation deductions of that amount in its state income tax returns. However, that element was only financially viable if no state in the US sought to tax the transferor on the US$4 billion gain on the transfer.
At the meeting on 18 July 2001 with the IDR, ITW Inc’s concerns were realised. The IDR advised that the proposed transfer of the royalty rights for US$4 billion would give rise to a taxable gain in Illinois because of the actions of the resident Illinois officers and directors (as opposed to the actions of the Delaware employee). The tax on the gain, based on the 7% cumulative Illinois state tax rate, was estimated to be US$300 million.
During the course of the meeting with the IDR, Sutherland identified two Australian taxation planning advantages of the proposed series of transactions:
1.in relation to the proposed consolidation legislation (see [6] to [9] and [20] to [22] above), a potential advantage in relation to offsetting the cost base of assets of subsidiaries where there had previously been a “sister to sister” rollover transaction in the event that the consolidation legislation contained a provision restricting resetting in those circumstances; and
2.a potential capital loss on the sale of SGTS by AFC.
As a result of the discussion at the meeting on 18 July with the IDR, Sutherland and other ITW Inc officers and advisers held further meetings and discussions. Ultimately, Lieberman developed what was described by Sutherland as “a novel and previously untested structure … to avoid the technical hurdle presented by the [IDR]”. The “new” structure – involving the use of a “member managed LLC” – was adopted.
On 20 August 2001, a private letter ruling request was lodged with the IDR. Sutherland described the request as setting out the following transactions:
a) [ITW PMI] was to contribute the royalty streams to [CSC] and other assets in its capacity as the CSC’s sole member;
b) CSC was to transfer the royalty streams to CSF in exchange for a promissory note in the sum of US$4 billion;
c) CSF was to contribute US$1 billion to the capital of CSA, its Australian subsidiary. This contribution was to be made by way of promissory note issued by CSF for the sum of US$1 billion;
d) CSA was to, in turn, contribute US$1 billion to the capital of AFC, its Australian subsidiary. This contribution was to be made by endorsement of the US$1 billion promissory note in favour of AFC;
e) AFC was to purchase the royalty streams from CSF, in consideration for endorsing the US$1 billion promissory note in favour of CSF and issuing a further promissory note in favour of CSF in the sum of US$3 billion; and
f) AFC was to transfer the royalty streams and assign its obligations under the US$3 billion promissory note to its subsidiary, SGTS, in consideration for the issue of preferred stock by SGTS and common stock. This preferred stock would include terms that would mean it would be treated as debt for US federal income tax purposes.
(Emphasis added.)
Sutherland’s evidence was that as both CSA and AFC were to be treated as branches of CSF for the purposes of US tax laws, the US tax effect of SGTS issuing preferred stock to AFC was that the US tax law treated the stock as having been issued to CSF and treated the preferred stock as debt for both US federal and US state income tax purposes.
A revised request for a private letter ruling was lodged with the IDR on 10 September 2001. Before the revised request was lodged, Andersen Tax advised ITW Inc that the potential capital loss advantage (see [39] above) was no longer available. It is not clear whether ITW Inc told the IDR of this change before submitting the revised request on 10 September. In cross-examination, Sutherland could not recall whether he communicated this change to the IDR.
On 15 September 2001, the IDR issued the Private Letter Ruling. The Private Letter Ruling:
1.confirmed that CSC would not be taxable in Illinois on the gain or interest income to be derived by it as a result of the transactions and CSF would not be taxable in Illinois on the dividends (to be treated as interest) paid to AFC by SGTS (for Illinois tax purposes AFC was treated as a branch of CSF);
2.identified that liability for tax in the state of Illinois was a two step process. The first step involved determining whether an amount was to be included in a taxpayer’s base income and the second step involved the application of what was known as a “sales factor” to determine what amount would be taxable in the state of Illinois;
3.confirmed that the gain of US$4 billion would be included in CSC’s base income but then concluded that the US$4 billion gain was to be excluded from both the numerator and the denominator of CSC’s sales factor. As a result, the calculation of the sales factor, which determined the taxability of the whole of CSC’s base income, depended on the treatment of the interest income received by CSC on what was described as “Demand Note 1” (being the issue of a demand note from CSF to CSC); and
4.concluded that the interest would be excluded from the numerator of CSC’s sales factor and the interest derived by CSF on the preferred stock and on the US$3 billion note would be excluded from CSF’s sales factor.
There are other aspects of the Private Letter Ruling that must be noted. First, the Private Letter Ruling was issued on the basis that it was a single ruling. There was a close relationship between the interest/dividends derived by CSF and the interest derived by CSC – one was to be used to fund the other. Secondly, the Private Letter Ruling was issued subject to an important qualification, namely:
The facts upon which this ruling is based are subject to review by the [IDR] during the course of any audit, investigation or hearing and this ruling shall bind the [IDR] only if the material facts as recited in this ruling are correct and complete. This ruling will cease to bind the [IDR] if there is a pertinent change in statutory law, case law, rules or in the material facts recited in this ruling.
(Emphasis added.)
The qualification reflected s 1200.110(d) of the Illinois Administrative Code, tit 2, which relevantly provided that “[p]rivate letter rulings will cease to bind the [IDR] if there is a pertinent change in … material facts”.
Thirdly, the Private Letter Ruling incorporated a Statement of Facts prepared by ITW Inc which, after setting out a summary of the background and the relevant legal entities provided, in part:
C. The Transactions Completed Through June 18, 2001
The organization structure … would be adopted as part of an overall change to the manner in which ITW conducts business operations in Australia. Among other things, ITW is in the process of restructuring its Australian operations to: (1) improve the group’s operating efficiencies; (2) eliminate redundant companies; and, (3) take advantage of specific Australian tax planning opportunities.
The transactions in support of the Australian restructuring that have been completed through June 18, 2001, are both complex and numerous, …
D. The Transactions To Be Completed After June 18, 2001
To complete its Australian restructuring, the ITW affiliated group must execute certain additional intercompany transactions. The contemplated intercompany transactions include the following …
1. [ITW PMI] would contribute the following assets to [CSC] in its capacity as [CSC’s] sole member:
(a)Its entire interest in [CSF], which includes [CSF’s] respective interests in CSA, AFC, and SGTS …;
(b) …
(c)Its entire interest in two License Receivable Purchase Agreements (the “Purchase Agreements”). One such agreement concerns the right to receive designated receivables under an intangibles licensing agreement by and between ITW and its wholly-owned entity, ICBIL …, a Delaware limited liability company. The other agreement concerns the right to receive designated receivables under an intangibles licensing agreement by and between Miller … and its wholly-owned entity, BILCME …, a Delaware limited liability company.
2.Subsequent to the foregoing, [CSF] would transfer a demand note (“Demand Note 1”) to [CSC] in exchange for the Purchase Agreements. The value of Demand Note 1 would be U.S. $4 billion.
For federal tax purposes, the transfer of the Purchase Agreements from [CSC] to [CSF] in exchange for debt would be treated as a taxable event for U.S. federal income tax purposes. As contemplated, [CSC] would realize gain to the extent of the value of Demand Note 1. Pursuant to the U.S. federal consolidated return regulations, the full amount of the subject gain would not be recognized by [CSC] in the current tax year. To the contrary, recognition of the full gain would be deferred until a subsequent tax year following an event requiring recognition either in whole or in part.
3.Following the foregoing, [CSF] would contribute a demand note (“Demand Note 2”) to the capital of CSA in its capacity as CSA’s sole member. The value of Demand Note 2 would be U.S. $1 billion.
For U.S. federal tax purposes, the transaction would be ignored as a transaction between a corporation and its branch.
4. CSA would then contribute Demand Note 2 to the capital of AFC.
For U.S. federal tax purposes, the transaction would be ignored as a transaction between a branch of a corporation and another branch of the same corporation.
5.AFC would then use Demand Note 2 and its own purchase money note (“Purchase Money Note 1”) to acquire the Purchase Agreements from [CSF]. The value of Purchase Money Note 1 would be U.S. $3 billion.
For U.S. federal tax purposes, the transaction would be ignored as a transaction between a corporation and its branch. Moreover, Demand Note 2 would be extinguished upon its return to its issuer, [CSF].
6.AFC would then contribute the Purchase Agreements and its obligation under Purchase Money Note 1 to SGTS in exchange for an issuance of two classes of stock. The first class of stock would be voting common stock. All of the common shares would be issued to AFC. The second class of stock would be voting preferred stock. All of the voting preferred stock would be issued to AFC.
For U.S. federal tax purposes, the contribution would be subject to the non-recognition provisions of IRC section 351. In addition, due to the terms of the voting preferred stock issued to AFC by SGTS, this instrument would be characterized as debt for federal income tax purposes. Moreover, since AFC’s basis in the Purchase Agreements would exceed the value of the liabilities assumed by SGTS (Purchase Money Note 1 and the preferred stock), there should not be a federal tax consequence associated with the subject transfer.
…
(Emphasis added.)
Fourthly, the Private Letter Ruling contained the following additional statements:
… [CSF] would receive principal and interest payments from SGTS in connection with Purchase Money Note 1 as well as interest payments from the preferred stock. [Under the described facts, interest paid by SGTS in connection with the preferred stock would be paid to AFC. As noted, AFC would be classified as a branch of [CSF] for US tax purposes. Therefore, for US tax purposes, the subject income would be deemed to have been earned by [CSF] through one of its divisions. Solely for purposes of this PLR request, such interest income will generally be discussed as if it were paid directly by SGTS to [CSF]]. Likewise, SGTS would report its interest payments to [CSF] as a deductible expense for Illinois tax purposes without offset in combination.
…
No portion of the interest income paid to [CSF] by SGTS pursuant to Purchase Money Note 1 or the preferred stock should be included in the numerator of [CSF’s] Illinois sales factor.
…
Accordingly, [CSF] would not have Illinois income producing activities in connection with its receipt of interest income from Purchase Money Note 1 or the preferred stock.
…
Specifically, we request a ruling that:
… (iii)the interest paid to [CSF] by SGTS pursuant to Purchase Money Note 1 or the preferred stock should not be included in the numerator of [CSF’s] Illinois apportionment factor …
(Emphasis added.)
Finally, the Private Letter Ruling itself, as well as incorporating the facts outlined above, stated that:
… [Y]our letter states that the preferred stock of SGTS will be treated as debt for federal income tax purposes.
…
As set out above, the Department rules as follows:
… 2.Interest income of [CSF] with respect to Purchase Money Note 1 and SGTS preferred stock should not be included in the numerator of its sales factors since [CSF] does not conduct income-producing activity in Illinois.
The Private Letter Ruling requirement that SGTS issue preferred stock characterised as debt for US federal income tax purposes enabled SGTS to claim “interest” payable on that stock as income tax deductions. Of course, “interest” was in fact dividends payable on the preferred stock but treated as “interest”. In 2001, the present value of those “deductions”, after allowing for the fact that state taxes were deductible in calculating ITW Inc’s federal tax liabilities, was approximately US$10 million.
On or about 27 September 2001, the Australian Treasurer announced he had signed a protocol amending the Convention between the Government of Australia and the Government of the United States of America for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income (the USA DTA) and that legislation to formally ratify the protocol “[would] be introduced in the Australian Parliament as soon as practicable”.
The protocol “removed withholding tax on certain dividends, enabling major Australian public companies to bring profits made by their US subsidiaries back to Australia without any further tax being payable”. Specifically, the protocol provided:
1.no tax would be chargeable in the source country on dividends where a beneficially entitled company resident in the other country held 80% or more of the voting power of the company paying the dividends (and satisfied public listing requirements in the Limitation on Benefits Article); and
2.a limit of 5% would apply for other company shareholdings of 10% or greater (such limits applying to both franked and unfranked dividends).
These amendments to the withholding tax arrangements became significant during early November (see [114] and [121] below). The issue of withholding tax was addressed by Andersen Tax in its draft supplementary discussion paper on 8 November 2001: see [121] below.
(5) OCTOBER 2001
Having received the Private Letter Ruling from the IDR, the ITW Group moved to complete the remaining transactions in Project Gemini by 15 October or 31 October 2001 (at the latest). There were two reasons for this – ITW Inc had told the IDR that prompt action was required and, secondly, ITW Inc wanted to commence the transactions to obtain the benefit of the US state tax savings in October.
In fact, completion of the transactions was divided into two stages – 15 October and 15 November 2001.
Before turning to consider the events of 15 October and 15 November 2001, it is necessary to identify some events that occurred between the issue of the Private Letter Ruling and completion. One event occurred on or about 2 October 2001 and was described by Mr Chin in the following terms:
On or about 2 October 2001 I made a file note of a discussion I had with Mr Janetzki. That file note records that changes were being made to some of the steps in Project Gemini Prime (which was the description I used for the final stage of the project) because of the need to comply with an Illinois state tax ruling. I recall being told by Mr Janetzki that the ruling had been issued by the Illinois revenue authorities in relation to Project Gemini.
The file note was in evidence. Chin’s file note records that there “may be some changes to Gemini Prime [because] of the need [to] comply with the Illinois State Tax Ruling”. Chin’s evidence was not challenged and he was not cross-examined. The applicants rely upon this unchallenged evidence as demonstrating that the need to follow the facts in the Private Letter Ruling was of importance for ITW Inc and its advisers from the time they received the Ruling. Murtaugh gave similar evidence stating she believed the binding Private Letter Ruling confirming the gain would not be taxable “was essential for proceeding with Project Gemini”. The applicants submitted this was reinforced by consistent evidence of Sutherland (see [81] below), Wills (see [81] below) and Diskin (see [99] below) that, later when the foreign exchange accounting problem arose, ITW Inc considered it important to adhere strictly to the facts stipulated in the Private Letter Ruling.
During the same period, various emails flowed from Diskin and Janetzki to Sutherland, Murtaugh and other ITW Inc representatives in relation to various aspects of the structure of Project Gemini including, inter alia, the s 23AJ foreign dividend exemption. However, Arthur Andersen was unable to sign off on the Australian implications of the transactions as Wills was on leave.
On 15 October 2001 (as the flowchart at Annexure A demonstrates) the Steps numbered 1 and 2 in the Statement of Facts in the Private Letter Ruling at [46] above were completed. Specifically, the assignee of the royalty rights (ITW PMI) assigned those rights, by way of a contribution of capital, to CSC. On the same day, CSC assigned the royalty rights to CSF in consideration for the issue of a demand note of US$4 billion. The assignment and the consequences that flowed from it were important – it was the event that gave rise to a potential gain to CSC of US$4 billion and was the subject of the discussions with, and ultimately, the private letter ruling request to, the IDR. As noted at [38] above, the Illinois tax on this gain (if assessable) was approximately US$300 million, based on the 7% cumulative Illinois state tax rate.
The remaining transactions (described as Steps 3 to 6 in the Statement of Facts in the Private Letter Ruling at [46] above) that were to be undertaken following the assignment of the royalty rights to CSF were delayed. The transactions that were still to be completed after 15 October 2001 were:
1.the contribution by CSF of a demand note with a value of US$1 billion to the capital of CSA (Step 3 in the Statement of Facts in the Private Letter Ruling at [46] above);
2.the contribution of the same demand note by CSA to the capital of AFC (Step 4 in the Statement of Facts in the Private Letter Ruling at [46] above);
3.the acquisition of the royalty rights from CSF by AFC in consideration for the US$1 billion demand note and a purchase money note with a value of US$3 billion issued by it (Step 5 in the Statement of Facts in the Private Letter Ruling at [46] above); and
4.the contribution of the royalty rights and AFC’s obligations under the US$3 billion purchase money note to SGTS in consideration for the issue of SGTS voting common stock of US$10 million and SGTS voting preferred stock of US$990 million (Step 6 in the Statement of Facts in the Private Letter Ruling at [46] above).
During October 2001, various draft Certificates of Designation for the SGTS Preferred Stock were prepared by ITW Inc’s Delaware lawyers, MNAT, for discussion purposes. (Certificates of Designation set out the terms governing the stock). For the SGTS Preferred Stock to be characterised as debt for US tax purposes, ITW Inc had to be satisfied that, on balance, the instrument possessed more characteristics that were similar to ordinary debt rather than characteristics that were similar to ordinary equity.
On about 25 October 2001, ITW Inc received advice from Levy, a Chicago tax lawyer and ITW Inc’s senior external taxation adviser that the draft Certificates of Designation for the SGTS Preferred Stock “would not have sufficient hallmarks of debt”. The draft Certificates had a number of factors which the US advisers saw as unhelpful:
1.the type of instrument (i.e. the use of stock) and the voting rights attached to the stock, were factors consistent with ordinary equity and therefore unhelpful to ITW Inc’s preferred characterisation of the stock as debt for US tax purposes;
2.the ten year term of the instrument and the option to convert the preferred stock into ordinary stock also weighed against the characterisation of the instrument as debt; and
3.the changes proposed by the Australian advisers. I now turn to consider those changes in further detail.
There were tensions between the requirements in Australia and the requirements in the US about the terms of the SGTS Preferred Stock. From 10 October to 19 October 2001, Andersen Tax in Australia (who had been provided with and reviewed the drafts of the Certificate of Designation) had proposed that the SGTS Preferred Stock include terms to permit the stock to be characterised as a scheme giving rise to an equity interest under Div 974 of the 1997 Act as a precaution against s 23AJ of the 1936 Act being amended in the future to exclude from exemption any dividends paid on a scheme giving rise to a debt interest. Alternatively, Diskin, suggested that if the SGTS Preferred Stock were to be characterised as a scheme giving rise to a debt interest, there may need to be an unwind strategy in the event s 23AJ was amended.
In relation to the first alternative, Andersen Tax in Australia had advised Sutherland that SGTS should have an option on redemption to convert the stock into common stock. The presence of such an option was intended to ensure that the SGTS Preferred Stock would be treated as equity for Div 974 purposes, thus protecting ITW Inc against any future changes to s 23AJ of the 1936 Act. In addition, Andersen Tax recommended the terms include an option for AFC to convert the preferred stock to common stock. Despite these suggested changes, Diskin’s view at that time remained that the inclusion of options to convert the preferred stock into ordinary stock “may not get us all the way there, but as a belts and braces approach it is probably ‘as good as it gets’”. The difficulty was that the changes proposed by Andersen Tax in Australia had the effect of undermining the US tax characterisation of the instruments as debt instruments.
A further draft Certificate of Designation was produced on 26 October 2001. Diskin reviewed that instrument and requested further information about the US treatment of the stock in order to form a view on the treatment of the instruments under the Australian debt / equity measures. His opinion was sought in respect of various suggested amendments to the terms of the preferred stock that would see them as debt for US purposes and equity for Australian purposes. By email, Diskin said, inter alia:
But, my concern is why the IRS will accept that this is a debt interest ... . I would prefer not to go head to head with the ATO where we have to say it is not a debt interest for our rules and they can point to the in-substance approach by the US.
(Emphasis in the original.)
In response to an email from Murtaugh referring to the “revised option wording” in the terms of the preferred stock, Levy provided advice to ITW Inc on 29 October 2001. He said he had been referred to a specific Internal Revenue Service Revenue Ruling that addressed the characterisation of instruments as debt instruments under US federal tax law which he would look into. His advice was blunt – “Everyone thought we had no chance in the world”.
On 26 October (Chicago Time), Murtaugh provided Kropp (then ITW Inc’s Director of Corporate Accounting) with a copy of a slide pack of the Project Gemini transactions (which described the steps) that were to be proposed to be executed on 31 October 2001 and the then draft Certificate of Designation to be issued by SGTS.
On 29 October (28 October Chicago time), Kropp reviewed the documents. He was concerned the documents, if executed, would create a significant foreign exchange accounting issue for ITW Inc and formed the view that the transaction could not proceed if the foreign exchange accounting issue was not resolved.
At 3.30pm on 29 October (10.30pm on 28 October in Chicago), Kropp sent an email to ITW Inc’s auditors at Arthur Andersen in the US (Underwood and Foster), to ITW Inc’s then Chief Financial Officer (Rodriguez) and to one of Kropp’s employees. The email, entitled “Foreign Currency Issue”, outlined the foreign exchange accounting issue he had identified and stated:
As part of the Gemini tax transaction, a foreign currency question has come up.
The facts (greatly simplified as Gemini is quite a complex transaction):
· An Aussie subsidiary will end up holding an investment of A$1.0 billion in the preferred stock of a US subsidiary.
· The preferred stock is redeemable at some point in the future (5 years at the earliest).
· The preferred stock may be redeemed via the issuance of common shares.
· Due to the large amounts involved and the fact that it is denominated in US dollars, [T]reasury does not want to hedge the Aussie investment in US$ preferred stock. There is no economic exposure because it is in US$.
The accounting questions are as follows:
· Is the preferred stock accounted for as debt or equity? For Aussie tax purposes, it is treated as equity. For US tax purposes, it is treated as debt. Since the investment will eliminate in consolidation, the classification would normally not be important; however, it may impact the answer to the second question. Under US GAAP, I believe that mandatory preferred stock would be classified as debt, not equity.
· Since the Aussie company has a US$ investment, it has the currency exposure. The question is how to account for fluctuations in currency? Under SFAS [Statement of Financial Accounting Standards] 52, currency fluctuations related to consolidated investments in subs are recorded through CTA [Cumulative Translation Adjustments].
· Does this apply to preferred stock investments as well?
· If not, presumably we would have to mark-to-market each quarter.
· If so, what happens upon redemption? SFAS 52 says that current currency gains or losses on investments in subs are recorded if the investment is substantially liquidated. Does it matter if the redemption is made in cash or through conversion to common shares?
…
Since this transaction is happening right away (Wednesday), we need to discuss and resolve this right away. Given the large amount of the investment, a small currency fluctuation could result in a material impact on [Earnings Per Share] (eg a 10% swing equals $100 million).
…
In addition, the changes to Project Gemini were effected to ensure that ITW Inc avoided reporting any (potentially substantial) foreign exchange fluctuations in its quarterly reporting. That was achieved.
Nature of any connection between the taxpayer and person referred to in (vi) – s 177D(b)(viii)
It is common ground that all of the parties are wholly owned subsidiaries of ITW Inc.
Conclusion
For those reasons, I do not consider that the dominant purpose of either of the schemes identified by the Commissioner (encompassing changes to Project Gemini) was to obtain the tax deduction. Instead, the dominant purpose was to resolve the foreign exchange accounting issue in a manner consistent with the Private Letter Ruling issued by the IDR.
Further, for the reasons expressed at [303] to [313] above, I do not accept the Commissioner’s counterfactuals. Each was not an alternative means of achieving the commercial objectives of Project Gemini.
(4) PENALTIES
The Commissioner, by notice of assessment of penalty, imposed a penalty on Noza in respect of a purported tax shortfall in the 2003 to 2005 income years at the rate of 25%, determined on the basis that Pt IVA applied to disallow the deduction claimed by Noza in each year and that there was a reasonably arguable position that Pt IVA did not apply.
As I have concluded that part of the deduction is allowable and that Pt IVA does not apply to disallow the deduction claimed by Noza, it is necessary to consider the question of penalties only in relation to that part of the deduction not allowed. For the sake of completeness, I also make a number of findings relevant to the question of penalties in the context of the application of Pt IVA.
(a) Part of deduction not allowed
In relation to that part of the deduction not allowable as a deduction pursuant to s 25-90 (see [233] to [256] above), the applicants submitted that it was reasonably arguable that the amount was allowable pursuant to s 25-90 and therefore any penalty arising from the application of s 284-145 of Sched 1 to the TAA should be reduced to nil.
In my view, that contention must be rejected. In the 2003 year, s 284-145 imposed liability for administrative penalties, inter alia, if you attempted to reduce your tax liabilities through a scheme and it was reasonable to conclude that the entities entered into or carried out the scheme for the dominant purpose of getting a scheme benefit from the scheme. That did not occur here. As the Full Court said in Federal Commissioner of Taxation v Star City Pty Ltd (No 2) (2009) 180 FCR 448 at [25], s 284-145 “does not address the situation in which a taxpayer has sought to obtain a benefit or tax advantage by claiming in a taxation statement … a deduction for a loss or outgoing … being a deduction to which, on the proper application of the legislation, the taxpayer was not entitled”.
(b) Penalties and Pt IVA
As just noted, as part of the deduction was allowable pursuant to s 25-90 but not disallowed by operation of Pt IVA, I make the following findings for completeness. The issue before the Court was whether Noza had voluntarily told the Commissioner about the shortfall before the Commissioner told Noza that a tax audit would be conducted of its financial affairs for the period to which the shortfall relates.
If Noza had told the Commissioner about the shortfall before the tax audit commenced, any base penalty amount imposed on Noza would be reduced by 80% pursuant to s 284-225(2) of Schedule 1 to the TAA. If Noza voluntarily told the Commissioner about the shortfall after the tax audit commenced and telling the Commissioner about the shortfall can reasonably be estimated to have saved the Commissioner a significant amount of time and resources, then any base penalty imposed on Noza would be reduced by 20% pursuant to s 284-225(1) of Schedule 1 to the TAA. I will deal with each in turn.
In the 2003 year, s 284-225 of Schedule 1 to the TAA provided:
(1)The *base penalty amount for your *shortfall amount or *scheme shortfall amount, or for part of it, for an accounting period is reduced by 20% if:
(a)the Commissioner tells you that a *tax audit is to be conducted of your financial affairs for that period or a period that includes that period; and
(b)after that time, you voluntarily tell the Commissioner, in the approved form, about the shortfall amount or the part of it; and
(c)telling the Commissioner can reasonably be estimated to have saved the Commissioner a significant amount of time or significant resources in the audit.
(2)The *base penalty amount for your *shortfall amount or *scheme shortfall amount, or for part of it, for an accounting period is reduced under subsection (3) or (4) if you voluntarily tell the Commissioner, in the *approved form, about the shortfall amount or the part of it before the earlier of:
(a)the day the Commissioner tells you that a *tax audit is to be conducted of your financial affairs for that period or a period that includes that period; or
(b)if the Commissioner makes a public statement requesting entities to make a voluntary disclosure by a particular day about a *scheme or transaction that applies to your financial affairs – that day.
…
“Tax audit” was a defined term. It meant “an examination by the Commissioner of an entity’s financial affairs for the purposes of a taxation law”: s 995-1 of the 1997 Act.
The applicants identified the following documents as having been provided to the Commissioner before the beginning of the tax audit and disclosing the “shortfall amount”:
1.a letter dated 6 October 2004 from ITW Australia Pty Ltd, on behalf of Noza, to the Commissioner in response to a question from the Commissioner in a risk review in relation to the 2002 year of income. Noza provided the Commissioner with a detailed description of the relevant steps in Project Gemini. The description included identification of the quantum of the debt interest of $1,927,700,000 held by CSF in CSA and an explanation that the dividend payments on the redeemable preference shares issued by CSA would be treated as a debt deduction pursuant to s 25-90. The letter also identified the repayments due to be paid on the redeemable preference shares;
2.a letter dated 18 February 2005 from Noza, CSA and CSF to the Commissioner in which they sought a private ruling. The request set out the relevant transactions in Project Gemini and identified A$175,467,662 had been treated as interest for income tax purposes.
No other documents were identified by the applicants.
When did the audit start? In a letter dated 21 February 2005, from the Commissioner to ITW Inc it stated:
in accordance with previous discussions on 7 September 2004, we intend to commence an audit of the issues identified during the course of client risk reviews completed for the years ended 30 November 2001 to 30 November 2003 inclusive.
(Emphasis added.)
After closing submissions, the Commissioner communicated to the Court that after a review of the documentation, he no longer contended that the tax audit commenced before the letters of 6 October 2004 and 18 February 2005. Accordingly, the Commissioner accepted that he did not commence an audit of the 2003 year until after 21 February 2005.
The issue which remains is whether the applicant disclosed the shortfall amount before commencement of the audit. I accept that a private ruling request can provide the disclosure: see s 284-225 and the Explanatory Memorandum to the A New Tax System (Tax Administration) Bill (No. 2) 2000, para 1.138. In relation to the 6 October 2004 letter, it did not disclose the shortfall amount. So much was conceded by Senior Counsel for the applicants when he described the disclosure as “indirect”.
That leaves the 18 February 2005 letter. That letter dealt with withholding tax. It did not disclose a shortfall amount for the 2003 year or the deduction that would be claimed in the 2003 year.
For these reasons, I do not accept that either read separately or jointly, the 6 October 2004 letter and the 18 February 2005 letter constitute a disclosure of the shortfall amount prior to the commencement of the audit. Accordingly, I do not accept that the 25% penalty should be reduced by 80% of the amount assessed under s 284-225(2) of Sched 1 to the TAA.
Finally, there is the question of s 284-225(1) of Schedule 1 to the TAA. The applicants did not contend that they had satisfied s 284-225(1) and, no less importantly, led no evidence in relation to s 284-225(1)(c). I am not satisfied that s 284-225(1) is satisfied.
(5) WITHHOLDING TAX AND PT IVA – CSF
A further issue in the proceedings is whether Pt IVA authorised the Commissioner to determine that the dividend paid in 2003 by CSA to CSF in the sum of $222,655,981 was subject to dividend withholding tax under s 128B of the 1936 Act.
(a) Facts
The relevant facts have previously been described. For the purposes of this aspect of the appeals, the following events on 15 November 2001 are important:
1.941 fully paid redeemable preference shares were issued by CSA for A$2,048,565.36 per share to CSF in exchange for a US$1 billion demand note: see [126] above;
2.941 fully paid redeemable preference shares were issued by AFC for A$2,048,565.36 per share to CSA in exchange for the US$1 billion demand note: see [127] above;
3.AFC endorsed the US$1 billion demand note in favour of CSF and also issued a US$3 billion promissory note in favour of CSF, both in consideration for the purchase of certain royalty streams from CSF: see [128] above;
4.AFC transferred the royalty streams to SGTS in consideration for the issue by SGTS to it of nine shares of Series A preferred stock and 932 Series B preferred stock and the assumption by SGTS of AFC’s obligations pursuant to the US$3 billion promissory note in favour of CSF: see [129] above.
The terms of the redeemable preference shares issued by AFC and CSA included the following:
1.that each shareholder would be entitled to receive a cumulative preferential dividend out of the profits of the issuer at the rate of 6% of the paid up capital of each share annually on 15 November (the 6% dividend): see [126], [127] and [247] above;
2.that failing payment, the unpaid amount of the dividend would be carried forward to the following year and a default dividend calculated at the rate of 4.5757% per annum of the unpaid amount would become payable to the shareholder: see [126], [127] and [247] above;
3.within 45 days of the fifth anniversary of the issue date, the redeemable preference shares were required to be redeemed for A$1,927,700 per share: see [126], [127] and [247] above.
The terms of the Series B SGTS preferred stock instruments provided that dividends were payable out of funds legally available representing the accumulated earnings of the company: Art 3 (see [130(2)] above). The terms of the CSA Preference Shares provided that dividends were payable out of the profits of the company: Art 3.1 (see [126] above).
Following completion of the Project Gemini transactions, SGTS, as assignee of the royalty streams, earned substantial royalty income from ITW Inc and Miller calculated as a percentage of the sales of those companies:
Year ended 31 December
Royalty income
2001
US$190,464,104
2002
US$457,792,740
2003
US$500,586,614
On 14 November 2003:
1.SGTS paid a dividend in the sum of A$222,655,981, comprised of:
A$108,837,942 Dividend payable but unpaid on 15.11.02. A$4,980,097 Interest payable in respect of the unpaid 2002 accrued dividend. A$108,837,942 Dividend payable on 15.11.03.
2.SGTS and AFC entered into the Dividend Distribution Agreement pursuant to which SGTS issued a promissory note to AFC in the sum of A$222,655,981;
3.AFC and CSA each paid a dividend in the sum of A$222,655,981, respectively to CSA and to CSF comprised of:
A$108,837,942 Dividend payable but unpaid on 15.11.02. A$4,980,097 Default dividend payable in respect of the unpaid 2002 accrued dividend liability. A$108,837,942 Dividend payable on 15.11.03.
Payment in each case was effected by the endorsement of the SGTS Promissory Note.
On 24 November 2003, the SGTS promissory note was settled in full (along with A$77,311 of accrued interest) via an intercompany wire transfer of cash from SGTS to CSF: see [149] above.
On 13 May 2004, the board of directors of SGTS met and resolved that the declaration and payment of the dividend by SGTS on 14 November 2003, along with other miscellaneous actions, was ratified and made the acts and deeds of SGTS.
CSA was an Australian company and CSF was a US company.
(b) Withholding tax provisions
At all relevant times, the liability of a non-resident to pay withholding tax was determined by Div 11A of Pt III of the 1936 Act and specifically s 128B.
On 1 July 2001, amendments to the withholding tax provisions were made following the introduction of the debt / equity rules: New Business Tax System (Debt and Equity) Act 2001 (Cth). As a result of these amendments, amounts payable on the CSA Preference Shares would have been classified as interest instead of dividends and would have been subject to interest withholding tax under the 1936 Act instead of dividend withholding tax. Consequently, pursuant to Div 11A, had the amount been paid by CSA to CSF before 1 July 2003 it would have been subjected to interest withholding tax at a 10% rate. At that time, the US DTA did not affect the liability.
From 1 July 2003, the Protocol amending the US DTA came into effect, which had the effect, inter alia, of inserting a new Article 10 in the DTA: see [50] and [134] above. The Protocol was signed on 27 September 2001. However, it did not come into effect as a part of Australian law until 1 July 2003, after the passage of the International Tax Agreements Amendment Act (No 1) 2002 (Cth).
The effect of the amendment was to ensure that no tax, including withholding tax, would be payable in Australia on dividends paid to a company resident in the US, where that company beneficially owned 80% or more of the voting power in the Australian company which paid the dividend, and the other requirements of Art 16(2) or (5) were satisfied.
Pursuant to the US DTA (as amended by the Protocol), a payment from CSA to CSF would be characterised as a “dividend” because it would be “income from shares” within the meaning of Art 10(6) of the US DTA. That characterisation would override the characterisation in the 1936 Act. Article 10(3) provided that the withholding tax was reduced to nil if Art 10(3) applied. Article 10(3) of the US DTA applied if the person who was beneficially entitled to the dividends was a company that was a resident of the other Contracting State (namely, the US) that had owned 80% of or more of the voting power of the company paying the dividends for a 12-month period ending on the date the dividend is declared. This requirement was satisfied in this case. Accordingly, after 1 July 2003 a payment of the amount by CSA to CSF would be exempt from withholding tax. Indeed, the Commissioner accepted that but for the application of Pt IVA, no withholding tax was payable at the time that CSA purported to pay the dividend to CSF on 14 November 2003.
As noted at [134] above, on 11 September 2003, the International Tax Agreements Amendment Bill 2003 (Cth) was introduced. Section 3(2A) provided:
After the commencement of this subsection, a reference in an agreement to income from shares, or to income from other rights participating in profits, does not include a reference to a return on a debt interest (as defined in Subdivision 974-B of the [1997 Act]).
That had the effect that, as from 5 December 2003, a dividend paid by CSA to CSF would be subject to the interest article in the US DTA, namely Art 11, rather than the dividend article, Art 10.
When s 3(2A) is read together with Art 11(2), which provided that “[s]uch interest may be taxed in the Contracting State in which it has its source, and according to the law of that State, but the tax so charged shall not exceed 10 percent of the gross amount of the interest”, CSF would have become liable for withholding tax at a rate of 10% from 5 December 2003. There is no equivalent to Art 10(3) in Art 11.
Accordingly, as at 14 November 2003, when the dividend payment was purportedly made by CSA to CSF, s 3(2A) of the International Tax Agreements Act was not yet in force and Art 10(3) the US DTA had the effect of relieving CSF from any liability for withholding tax.
It is not in dispute that at the time of the payment of the dividend by CSA to CSF on 14 November 2003:
1.section 3(2A) of the International Tax Agreements Act did not yet apply; and
2.Art 10(3) instead applied, and its requirements being otherwise satisfied, the dividend was not subject to tax, or to withholding tax.
(c) Pt IVA of the 1936 Act
As noted earlier, the Commissioner submitted that Pt IVA applied to authorise him to determine that the dividend paid in 2003 by CSA to CSF in the sum of $222,655,981 was subject to dividend withholding tax under s 128B of the 1936 Act.
(i) Scheme
The scheme for the purposes of s 177A(1) of the 1936 Act was described by the Commissioner as the respective decisions to pay and the actual payment of the following amounts on 14 November 2003:
1.the purported dividend paid by SGTS to AFC;
2.the purported dividend paid by AFC to CSA; and
3.the purported dividend paid by CSA to CSF.
CSF did not dispute that the scheme identified by the Commissioner was capable of being a scheme for the purposes of s 177A(1) of the 1936 Act.
(ii) Tax benefit
Section 177F(2A) provides that where a tax benefit in the form of the avoidance of withholding tax has been obtained, or would but for that section be obtained, by a taxpayer in connection with a scheme, the Commissioner may determine that the taxpayer is subject to withholding tax under s 128B.
Section 177CA provides:
(1) This section applies in relation to a particular amount if a taxpayer is not liable to pay withholding tax on an amount where that taxpayer would have, or could reasonably be expected to have, been liable to pay withholding tax on the amount if a scheme had not been entered into or carried out.
(2) For the purposes of this Part, if this section applies in relation to an amount, the taxpayer is taken to have obtained a tax benefit in connection with the scheme of an amount equal to the amount mentioned in subsection (1).
(Emphasis added.)
In the present case, the “amount” is the payment of $222,655,981 by CSA to CSF. The Commissioner contended that CSF received a tax benefit within the meaning of s 177CA in relation to that amount because, in the absence of the scheme which had the effect of bringing the payment forward to 14 November 2003, the amount would have been paid later and withholding tax would have been payable. So, for example, if the amount had been paid by CSA to CSF after 5 December 2003, it would have been subject to withholding tax at 10%.
CSF rejected that contention. It submitted that the “amount” referred to in s 177CA is a reference to an actual payment, and not to a hypothetical payment never made. In particular, CSF submitted that s 177CA was premised on the existence of such an amount with the object of attacking arrangements where the form of an actual payment was modified to avoid withholding tax. CSF submitted that its construction of s 177CA was supported by an ordinary and natural construction of the words used in Pt IVA. In relation to its submission that the section was premised on the existence of a pre-existing amount, CSF referred to the following sections:
1.s 177CA which refers to “an amount” in respect of which withholding tax would have been payable if a scheme had not been entered into or carried out;
2.s 177F(2A) which refers to the Commissioner making a determination that the taxpayer is subject to withholding tax “on the whole or a part of that amount”;
3.s 177F(2C) refers to a determination being given to the “person who paid the amount”; and
4.the statutory fiction created by s 177F(2F) is limited to a fiction that withholding tax was always payable in contradistinction to s 177F(2), which does not create a further fiction that a payment was made when one was not in fact made.
I accept CSF’s contention that the phrase “particular amount” in s 177CA is a reference to the amount of withholding tax avoided by reason of the entry into of the scheme..
CSF also referred to the following extracts from the WHT EM, which introduced s 177CA, as further support for its construction of s 177CA. The WHT EM stated at pars 2.35 and 2.36 as follows:
2.35New subsection 177CA(1) will specify a particular amount (of interest, dividends or royalties paid to the taxpayer) to which section 177CA is to apply. Such an amount will have both of the following characteristics:
·as a result of the entering into or the carrying out of a scheme, the taxpayer is not liable to pay withholding tax on the amount. (The existing definition of 'scheme' contained in section 177A(1) applies to this subsection); and
· there is a reasonable expectation that, if the scheme had not been entered into or carried out, then a liability to the taxpayer for withholding tax on that amount, would have arisen.
2.36Where there is a ‘new subsection 177CA(1) amount’ new subsection 177CA(2) will apply to designate that amount to be a tax benefit. New subsection 177CA(2) further specifies that the tax benefit is taken to have been obtained by the taxpayer.
…
(Emphasis added.)
CSF submitted that the references to an “amount” in respect of which a liability to pay withholding tax “would have arisen” provided further support for the construction that s 177CA is premised upon the actual payment of an amount to a non-resident.
The Commissioner rejected that construction on the grounds that it was contrary to the purpose of the provisions and would lead to the absurd result that s 177CA could have no application to schemes that operate by altering the timing of a payment so as to give rise to a tax benefit. Instead, the Commissioner submitted that provided there is an “amount”, in this case $222,655,981, and provided there is a scheme, the entry into of which avoids a liability to pay withholding tax, then s 177CA can apply.
In support of that construction of s 177CA, the Commissioner raised four points:
1.CSF’s construction was purely grammatical without having regard to the Parliamentary intent of those provisions: cf Cooper Brookes (Wollongong) Pty Ltd v Federal Commissioner of Taxation (1981) 147 CLR 297 at 321 and CIC Insurance Limited v Bankstown Football Club Limited (1997) 187 CLR 384 at 408.
2.it is contrary to Parliament’s intention, as expressed in the WHT EM, that s 177CA have a comprehensive operation with respect to schemes to avoid withholding tax. The Commissioner referred to paragraphs 2.2, 2.12 and 2.30 of the WHT EM:
2.2The purpose of these amendments is to provide a mechanism within the Act to effectively counter withholding tax avoidance arrangements in a general and comprehensive way …
2.12… to provide a mechanism within the Act to effectively counter withholding tax avoidance schemes in a comprehensive way it has become necessary to expand the effect of Part IVA to include avoidance of withholding tax on an amount of interest, dividends or royalties because of a scheme as defined in Part IVA.
…
2.30New section 177CA will be inserted into Part IVA. This section will extend the operation of Part IVA to arrangements which avoid an amount of withholding tax which would otherwise be levied under s 128B.
3.if CSF’s submission was correct, then arguably s 177D(b)(iii) would not be taken into account which would be inconsistent with Parliament’s intention that all of the s 177D(b) factors remain relevant to withholding tax schemes as recorded in paragraph 2.41 of the WHT EM:
The proposed legislation makes no amendments to section 177D. Its provisions therefore apply without alteration to new section 177CA in the same way as to section 177C.
4.CSF’s submission was inconsistent with the way in which withholding tax is levied. The Commissioner submitted that ss 177CA and 177F(2A) contain no reference to years of income because it is not imposed by assessment but by imposing a withholding tax liability with respect to amounts paid with the withholding tax liability automatically becoming a debt owed to the Commonwealth: see ss 128B and 128C of the 1936 Act. Accordingly, it would be inconsistent with the basis on which withholding tax is levied to interpret s 177CA as requiring a particular temporal requirement.
In the end it is unnecessary to resolve the dispute. At the time the scheme was entered into (14 November 2003) and at the time the “amount” was paid (24 November 2003), the law did not impose withholding tax on dividends paid by CSA to CSF, nor was there any means to modify the form of the payment of any such dividend to create such a liability. As a result, no counterfactual can be devised or hypothesised whereby it can be concluded that dividend withholding tax would, or might reasonably be expected, to have been payable on a payment made in November 2003. That is because all such dividends, regardless of form, were exempt from tax where the requirements of Art 10(3) were satisfied. Put another way, the obligation to pay dividends annually had existed since November 2001. That obligation was cumulative. The right to further dividends arose on 15 November 2003. There was no suggestion (and nor could there be) that the fact the arrangements were entered into in 2001, or their content, formed part of the scheme.
The identification of the scheme is important. The Commissioner contended that the payment was brought forward. The date the obligation fell due (15 November 2003) was established in November 2001 and was not altered. The amount was discharged by the endorsement of a promissory note which was not only due but paid on 24 November 2003. At both 15 and 24 November, the law did not impose withholding tax on dividends paid by CSA to CSF.
It is not permissible to assess the existence of a tax benefit by law which was introduced after the payment of the “particular amount”. As Hill J decided in CPH Property Pty Ltd v Federal Commissioner of Taxation (1998) 88 FCR 21 at 42:
In my view the application of the Part can only be tested with respect to the obtaining of a tax benefit in accordance with the law as applicable to the time the scheme is entered into or carried out.
That observation was endorsed by the Full Federal Court on appeal: Commissioner of Taxation v Consolidated Press Holdings Ltd (No 1) (1999) 91 FCR 524 at 552.
For these reasons, I do not accept that there is tax benefit to be cancelled pursuant to ss 177CA and 177F of the 1936 Act and Pt IVA does not apply to the scheme identified by the Commissioner.
(iii) Dominant purpose
Even if there was a tax benefit (contrary to the view that I have formed), I do not accept that it could be concluded that the dominant purpose of any part of the Commissioner’s scheme was to obtain a tax benefit. The following facts are worth restating:
1.the parties entered into arrangements for the funding of an acquisition and sale of certain royalty streams in 2001. For the reasons set out in [293] to [376] above, the dominant purpose of those arrangements was to obtain US state tax benefits and to facilitate protection of ITW Inc’s intellectual property;
2.part of those arrangements included the issue by CSA of redeemable preference shares using standard terms for the payment of dividends and for the redemption of the shares after five years. The Commissioner did not submit that the terms used were, to any extent, modified or altered to avoid a liability for withholding tax;
3.the terms of issue of the CSA Preference Shares required the payment of a fixed dividend amount on 15 November each year. That obligation was an expected feature of redeemable preference shares, was cumulative and subject to default dividend interest;
4.in accordance with its terms, a dividend was paid in November 2003: see [135] to [148] above. That dividend included payment of the dividend for the 2002 year (payment had been suspended for one year) and a dividend amount representing interest on the unpaid 2002 dividend. Nothing was done to alter the form or amount of the dividend to avoid withholding tax.
Against the background of those facts, I turn to consider the factors in s 177D(b).
Manner
The Commissioner submitted that the decision to pay the amount of $222,655,981 was “contrived” to ensure that the payment was made prior to 5 December 2003 after which date withholding tax would have been payable on the payment from CSA to CSF.
In support of that contention, the Commissioner referred to the fact that there were not sufficient accumulated earnings for the dividend to be paid by SGTS to AFC: see [139] to [144] above. I accept that there were not sufficient accumulated earnings for the dividend to be paid by SGTS to AFC. However, for the reasons stated at [208] to [213] above, I do not accept that it invalidated the payment of dividends from SGTS to AFC and the subsequent dividends that flowed through to CSF.
I accept that the decision to pay the amount of $222,655,981 was made prior to 5 December 2003, after which date withholding tax would have been payable on the payment from CSA to CSF. I do not accept that that decision was “contrived”.
Form and substance of the scheme
I accept that the economic and commercial substance of the scheme was the three payments on 14 November 2003, namely a payment by SGTS to AFC, a payment by AFC to CSA and a payment by CSA to CSF. I do not accept that the form of the scheme was different from its economic and commercial substance. Why? The premise which underpinned the Commissioner’s contention – that no dividend could properly be paid by SGTS to AFC – was contrary to the facts and the law: see [208] to [213] above.
Timing
The Commissioner submitted that the timing of the scheme was dictated by two events, without which the scheme would not have proceeded.
First, the US DTA came into effect in Australia on 1 July 2003, the Protocol having been signed by the US and Australia on 27 September 2001. Under the US DTA, no withholding tax was payable on dividends where the recipient of the dividends held more than 80% or more of the shares in the paying company.
Secondly, the International Tax Agreements Amendment Bill 2003, which was introduced on 11 September 2003, clarified the operation of the dividend provisions of the US DTA, such that amounts treated as a return on a debt interest were not to be characterised as dividends: Explanatory Memorandum, International Tax Agreements Amendment Bill 2003, paragraphs 3.9-3.19 and [402] to [409] above.
I accept that the payment by CSA to CSF on 14 November 2003 was, therefore, in the “window” in which no withholding tax was payable. However, I do not accept that the timing is determinative. As the Commissioner submitted, a withholding tax liability is imposed with respect to amounts paid with the withholding tax liability automatically becoming a debt owed to the Commonwealth: see ss 128B and 128C of the 1936 Act. When the dividend was paid, no withholding tax was payable.
Result Achieved by the Scheme
The Commissioner submitted that the result but for the scheme was that CSF was not liable to pay withholding tax on the amount of $222,655,981. But that was the law as at the date of the scheme.
Change in financial position of the taxpayer from the scheme
The steps in the scheme affected the financial position of CSF. It would have received the gross amount and not the net amount of the dividends. But that was what the law was at the date of the scheme.
Change in financial position of any connected person from the scheme
The transactions took place within a wholly-owned group of companies.
The scheme had the effect that, within the ITW Group, intra-group liabilities with respect to accrued dividend payments were discharged through the payment of the promissory note. The financial position of the group, when viewed as a whole, is such that the payments (including the relevant payment from CSA to CSF), was altered only insofar as there was a reduction in the withholding tax liability of the group on the dividend payments received by CSF. A reduction that was legally permissible – that was what the law provided at the time of the scheme.
Any other consequences of the scheme for the taxpayer or any connected person
The Commissioner accepted that there were no other consequences of the scheme for the taxpayer or any other person and that this factor was neutral.
Nature of connection between the taxpayer and persons affected by the scheme
All of the relevant entities are members of the one corporate group, namely the ITW Group.
(d) Conclusion
The parties entered into arrangements for the funding of an acquisition and sale of certain royalty streams where the dominant purpose of those arrangements was to obtain US state tax benefits and to facilitate protection of ITW Inc’s intellectual property. The arrangements included the issue by CSA of redeemable preference shares using standard terms for the payment of dividends and for the redemption of the shares after five years. It was not suggested that the terms used were, to any extent, modified or altered to avoid a liability for withholding tax. Nor was it suggested that the size of the dividend reflected anything other than an ordinary market return on an instrument of that nature.
The terms of issue of the CSA Preference Shares required the payment of a fixed dividend amount on 15 November each year. That obligation was and remains an expected feature of redeemable preference shares.
In accordance with the ordinary commercial terms of the CSA Preference Shares, a dividend was paid in November 2003. That dividend included payment of the dividend for the 2002 year (payment had been suspended for one year) and a dividend amount representing interest on the unpaid 2002 dividend. Nothing was done to alter the form or amount of the dividend to avoid withholding tax. Indeed, given that no withholding tax was then payable, nothing could be done to make dividend withholding tax payable on the dividend paid given CSA’s ownership by CSF.
For these reasons, I do not accept that it could be concluded that any party to the scheme had a dominant purpose of obtaining the alleged tax benefit.
D. CONCLUSION AND ORDERS
Given the complexity of the issues in these proceedings, I will direct the parties to bring in orders to give effect to these reasons for decision by 4.00pm on 18 February 2011.
I certify that the preceding four hundred and forty-five (445) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Gordon. Associate:
Dated: 4 February 2011
Key Legal Topics
Areas of Law
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Taxation Law
Legal Concepts
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Deductibility of Dividends
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Tax Benefit
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Voluntary Disclosure
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Administrative Penalties
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Constitutional Validity
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