Resource Capital Fund Iii LP v Commissioner of Taxation
[2013] FCA 363
FEDERAL COURT OF AUSTRALIA
Resource Capital Fund III LP v Commissioner of Taxation [2013] FCA 363
Citation: Resource Capital Fund III LP v Commissioner of Taxation [2013] FCA 363 Parties: RESOURCE CAPITAL FUND III LP v COMMISSIONER OF TAXATION File number: NSD 638 of 2011 Judge: EDMONDS J Date of judgment: 26 April 2013 Catchwords: DOUBLE TAXATION TREATIES – United States Double Taxation Convention – principles of and materials in aid of interpretation – taxation of gains derived from disposition of shares in a company owning real property (mining tenements) situated in Australia by a limited partnership formed outside both Australia and the United States but comprised of limited partners being predominantly United States residents – whether gain derived by limited partnership or limited partners for the purpose of the Convention – reconciliation with any inconsistency under Australia’s domestic law – Div 5A of Pt III of Income Tax Assessment Act 1936 (Cth)
INCOME TAX – Div 855 of Pt 4-5 of Income Tax Assessment Act 1997 (Cth) – whether capital gains derived by a foreign resident to be disregarded – whether “principal asset test” in s 855-30 passed – consideration of what is to be valued and compared as the criterion for passing the test – hypotheses and methodologies of valuation to be adopted
Legislation: International Tax Agreements Act 1953 (Cth) ss 4, 6, 6AA
Schedule 2 – Convention between the Government of the Commonwealth 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
Schedule 2A – United States Protocol: 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 (27 September 2001): Arts 1, 3, 4, 7, 13
Former Schedule 2 - Convention between the Government of the Commonwealth 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 (14 May 1953): Art II
Taxation Administration Act 1953 (Cth) s 14ZYA(3)
Income Tax Assessment Act 1936 (Cth) Div 5A (ss 94A–94Y), s 167
Income Tax Assessment Act 1997 (Cth) ss 855-1 to 855-30, s 995-1
Evidence Act 1995 (Cth) s 79
Internal Revenue Code 1986 (US) §701, §7701
Vienna Convention on the Law of Treaties [1974] ATS 2Cases cited: Alcan (NT) Alumina Pty Ltd v Commissioner of Territory Revenue (2009) 239 CLR 27 cited
Applicant A v Minister for Immigration and Ethnic Affairs (1997) 190 CLR 225 cited
Arnotts Ltd v TPC (1990) 24 FCR 313 cited
Boland v Yates Property Corporation (2007) 167 ALR 575 cited
Commissioner of State Taxation (WA) v Nischu Pty Ltd (1991) 4 WAR 437 followed
Commissioner of Taxation v Consolidated Media Ltd [2012] HCA 55 cited
Commissioner of Territory Revenue v Alcan (NT) Alumina Pty Ltd (2008) 156 NTR 1 cited
Dasreef Pty Ltd v Hawchar (2011) 243 CLR 588 cited
Federal Commissioner of Taxation v Lamesa Holdings BV (1997) 77 FCR 597 cited
Federal Commissioner of Taxation v Murry (1998) 193 CLR 605 cited
Federal Commissioner of Taxation v SNF (Australia) Pty Ltd (2011) 193 FCR 149 followed
Federal Commissioner of Taxation v United Aircraft Corporation (1944) 68 CLR 525 cited
McDermott Industries (Aust) Pty Ltd v Federal Commissioner of Taxation (2005) 142 FCR 134 cited
Minister for Home Affairs v Zentai (2012) 289 CLR 644 referred to
Nischu Pty Ltd v Commissioner of State Taxation (WA) 21 ATR 391 followed
Pan Pharmaceuticals Ltd (in Liq) v Selim [2008] FCA 416 cited
Pancontinental Mining Ltd v Commissioner of Stamp Duties [1989] Qd R 310 cited
Project Blue Sky Inc v Australian Broadcasting Authority (1998) 194 CLR 355 cited
Russell v Federal Commissioner of Taxation (2011) 190 FCR 449 explained
Spencer v The Commonwealth (1907) 5 CLR 418 cited
Sydneywide Distributors Pty Ltd v Red Bull Australia Pty Ltd (2002) 55 IPR 354 cited
Thiel v Federal Commissioner of Taxation (1990) 171 CLR 338 followedVirgin Holdings SA v Commissioner of Taxation (2008) 70 ATR 478 approved
Richard E Andersen, Analysis of United States Income Tax Treaties (2011)
OECD – Model Tax Convention on Income and on Capital (15 July 2005) and Commentary
United States Model Income Tax Convention of November 15, 2006
OECD Report (20 January 1999): “The Application of the OECD Model Tax Convention to Partnerships”
Treasury department (US) technical explanation of the Convention (2 December 1983)
Department of the Treasury (US) technical explanation of the Protocol
Explanatory Memorandum to the International Tax Agreements Amendment Bill (No 1) 2002Date of hearing: 3, 4, 5 and 6 December 2012 Date of last submissions: 10 December 2012 Place: Sydney Division: GENERAL DIVISION Category: Catchwords Number of paragraphs: 167 Counsel for the Applicant: Mr AH Slater QC with Mr BL Jones Solicitor for the Applicant: Clayton Utz Counsel for the Respondent: Mr AJ Payne SC with Ms M Baker Solicitor for the Respondent: Maddocks Lawyers
IN THE FEDERAL COURT OF AUSTRALIA
NEW SOUTH WALES DISTRICT REGISTRY
GENERAL DIVISION
NSD 638 of 2011
BETWEEN: RESOURCE CAPITAL FUND III LP
ApplicantAND: COMMISSIONER OF TAXATION
Respondent
JUDGE:
EDMONDS J
DATE OF ORDER:
26 APRIL 2013
WHERE MADE:
SYDNEY
THE COURT ORDERS THAT:
1.The appeal be allowed.
2.The respondent’s deemed objection decision be set aside.
3.The applicant’s objections to the assessment of income tax and to the assessment of administrative penalty be allowed in full.
4.The respondent pay the applicant’s costs as agreed or taxed.
Note:Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011.
IN THE FEDERAL COURT OF AUSTRALIA
NEW SOUTH WALES DISTRICT REGISTRY
GENERAL DIVISION
NSD 638 of 2011
BETWEEN: RESOURCE CAPITAL FUND III LP
ApplicantAND: COMMISSIONER OF TAXATION
Respondent
JUDGE:
EDMONDS J
DATE:
26 APRIL 2013
PLACE:
SYDNEY
REASONS FOR JUDGMENT
INTRODUCTION
On 26 July 2007, the applicant (“RCF”) sold 52.5 million fully paid ordinary shares in St Barbara Mines Ltd (now called St Barbara Limited) (“SBM”), comprising 5.68% of the capital of SBM which it had acquired in March 2006 as part of a larger parcel of 100 million such shares comprising 11.95% of the capital of SBM.
On 29 January 2008, RCF sold its remaining shares in SBM.
The total gain on the two sales was $58,250,000 less transaction costs of $612,109 (it is not in contest that the assessment referred to in [4] below is excessive at least to the extent that those costs were not deducted from the gain assessed).
On or about 1 November 2010, the respondent (“Commissioner”) issued RCF with a notice of assessment (“the Assessment”) under s 167 of the Income Tax Assessment Act 1936 (Cth) (“the 1936 Act”) for the year of income ended 30 June 2008 (“year of income”). The Assessment included a net capital gain in the sum of $58,250,000.
On or about the same date, the Commissioner issued RCF with a notice of assessment of administrative penalty in the sum of $13,106,250, being 75% of the tax liability (“Penalty Assessment”).
RCF lodged objections against the Assessment and the Penalty Assessment.
The Commissioner allowed in part RCF’s objection against the Penalty Assessment by reducing the administrative penalty from 75% to 25%, being the sum of $4,368,750, on the ground that RCF was co-operative and had “a reasonably arguable position”.
On 12 May 2011, RCF’s objection against the Assessment was deemed, by the effluxion of time, to have been disallowed by operation of s 14ZYA(3) of the Taxation Administration Act 1953 (Cth) (“the TAA”).
By amended application dated 8 July 2011, RCF applied to this Court by way of appeal against the Commissioner’s deemed objection decision. For the reasons which follow, I have concluded that RCF’s appeal should be allowed and the Commissioner’s deemed objection decision set aside.
PRIMARY FACTS RELEVANT TO ISSUES IN DISPUTE
The primary facts relevant to the issues in dispute are uncontroversial.
RCF is a limited partnership formed in the Cayman Islands under the Exempted Limited Partnership Law 1991 (revised in 1997 and again in 2001) of that jurisdiction pursuant to a written partnership agreement dated 17 January 2003. Its general partner is Resource Capital Associates III LP, a limited partnership formed in the Cayman Islands, and its affairs are managed by RCF Management LLC, a Delaware limited liability company, in Denver, United States of America (“US”). More than 97% of the contributed capital of RCF is held by US residents, principally funds and institutions.
At all material times, RCF was comprised of one general partner and 61 or 62 limited partners. No limited partner had greater than 8.5% interest in the contributed capital of RCF.
Neither RCF nor any of the partners in RCF were resident in Australia at any time during the year of income.
SBM at all relevant times conducted a gold mining enterprise on mining tenements in Australia owned by it, using plant, equipment, mining information and other assets held by it. The mining tenements were, and the other assets were not, “taxable Australian real property” (“TARP”) of SBM for the purposes of Div 855 of the Income Tax Assessment Act 1997 (Cth) (“the 1997 Act”). The value of the several assets of SBM is the subject of expert evidence expressing views which, in many respects, differ to a greater or lesser extent.
At all relevant times, SBM’s fully paid ordinary shares had been listed on the Australian Securities Exchange (“ASX”). The key assets of SBM in the year of income were its Southern Cross and Leonora operations, both of which are located in Western Australia. SBM’s Southern Cross operations primarily comprised the Marvel Loch underground mine. SBM’s Leonora operations primarily comprised the Gwalia underground mine.
RCF’S TAX STATUS UNDER AUSTRALIAN DOMESTIC LAW
Division 5A of Pt III (ss 94A–94Y) of the 1936 Act was inserted by Act No 227 of 1992 and provided for certain limited partnerships to be treated as companies for tax purposes for the 1995–1996 and later years of income.
In the year of income, RCF was a limited partnership as defined in para (a) of the definition of that term in s 995-1(1) of the 1997 Act.
In the year of income, RCF was a corporate limited partnership within the meaning of s 94D(1) of the 1936 Act, and was not excluded as such by the provisions of s 94D(2) or s 94D(5).
In the year of income, s 94J of the 1936 Act had the effect that, with certain limited exceptions, references to a “company” in the 1936 Act and the 1997 Act (together “the Assessment Acts”) were taken to include RCF, as a corporate limited partnership.
In the year of income, ss 94T and 94U of the 1936 Act respectively had the effect that, for the purposes of the Assessment Acts, RCF was not a resident of Australia and was incorporated in the Cayman Islands under the laws in force in that jurisdiction.
RCF’S TAX STATUS UNDER US DOMESTIC LAW
A partnership is “domestic” for US tax purposes if it is created or organised in the US or under US or state law: US Internal Revenue Code (“IRC”) § 7701(a)(4). A partnership that is not domestic is foreign: IRC § 7701(a)(5). RCF is a foreign partnership for US tax purposes because it was organised under the laws of the Cayman Islands.
For US tax purposes a partnership, whether resident in the US for US tax purposes or not, is a “fiscally transparent” or “flow-through” entity not subject to tax; the liability for US tax, if any, on the income of the partnership falls on the partners: IRC §701.
Under US law, each partner of RCF derives its proportionate share of the income of the partnership. Liability for US tax, if any, falls on the partner or, if the partner is a “fiscally transparent” or “flow through” entity, the US owner or owners of the partner, unless the person in question is a tax-exempt organisation.
The gain on RCF’s sale of the SBM shares was taxable, or exempt, in the US in the hands of the limited partners. It was not taxable in the hands of RCF because of RCF’s “fiscally transparent” or “flow-through” status. While RCF is not treated as a taxpayer for US tax purposes, the gain on the sale was disclosed in the partnership returns filed by RCF in the US.
COMPARATIVE STATUS OF RCF UNDER DOMESTIC LAW
Thus, while a corporate limited partnership, such as RCF, is treated as a separate taxable entity for Australian tax purposes, irrespective of whether it is a resident of Australia for Australian income tax purposes or not, such a partnership is treated as fiscally transparent or flow-through for US tax purposes, and again irrespective of whether it is resident in the US for US tax purposes or not.
These treatment differences create various difficulties when it comes to applying the provisions of double tax treaties to partnerships. These difficulties are analysed in the report adopted by the OECD Committee on Fiscal Affairs on 20 January 1999 entitled: “The Application of the OECD Model Tax Convention to Partnerships”, the conclusions from which have been incorporated in the OECD Commentary on Art 1 and certain other provisions of the OECD Model Tax Convention on Income and on Capital 2005 (“OECD Model”) (see [39] below).
ISSUES
The issues in this appeal are:
(1)Whether the Assessment could properly be issued to RCF, or whether it is precluded by the International Tax Agreements Act 1953 (Cth) (“the Agreements Act”), specifically, Sch 2 to the Agreements Act: 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 the Fiscal Evasion with respect to Taxes on Income (“the Convention”, inclusive of the amendments in Sch 2A made by the 2001 Protocol hereinafter referred to); and if it could properly be issued
(2)whether any capital gain is required to be disregarded by s 855-10 of the 1997 Act because the sum of the market values of SBM’s TARP assets did not exceed the sum of the market values of SBM’s non-TARP assets at the dates of disposition of interests in SBM by RCF.
FIRST ISSUE: THE TREATY ISSUE
It may assist the reader to understand what this issue involves and the relevance of the matters taken into account in the process of reasoning in reaching the conclusion I have, if, at the outset, I shortly state the two alternatives contended for: the Commissioner contends that under the Convention, as under Australia’s domestic law, RCF is the relevant entity for the purposes of assessing the gain made on the sale of the SBM shares; while RCF contends that under the Convention the relevant entities, if any, are the limited partners resident in the US.
The Convention
The primary purpose of a tax treaty is to promote international trade by removing obstacles that double taxation presents to the development of economic relations between the countries: Richard E Andersen, Purpose of Income Tax Treaties in Analysis of United States Income Tax Treaties (2011) at Ch 1.01. The purpose of the Convention is to avoid the double taxation of the income of residents of the US and Australia.
Australia and the US entered into the Convention on 6 August 1982. According to the Treasury department (US) technical explanation of the Convention (“Technical Explanation 1983”), the Convention was negotiated on the basis of the US Model Convention for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital, published in May 1977, the revised US Model published in draft form in June 1981, and the 1977 OECD Model. The Convention replaced a prior income tax convention between Australia and the US dated 14 May 1953 (“the 1953 Convention”).
In 2001, Australia and the US signed a Protocol amending the Convention (“the 2001 Protocol”). According to the Department of the treasury (US) technical explanation of the 2001 Protocol (“Technical Explanation 2001”), negotiations took into account the US Treasury Department’s current tax treaty policy, the then current (1996) US Model, the Australian Model Tax Convention, the 2000 version of the OECD Model, and recent tax treaties concluded by both countries.
The Australian taxes to which the Convention applies include the Australian income tax including tax on capital gains: Art 2(1)(b)(i).
The Agreements Act
The Convention was given the force of law in Australia by ss 6 and 6AA of the Agreements Act.
Subsection 4(1) of the Agreements Act provides that, subject to subs (2), the Assessment Acts are incorporated and read as one with the Agreements Act.
Subsection 4(2) of the Agreements Act provides:
The provisions of this Act have effect notwithstanding anything inconsistent with those provisions contained in the Assessment Act (other than Part IVA of that Act) or in an Act imposing Australian tax.
Relevant Provisions of the Convention
Article 1 relevantly provides:
ARTICLE 1
Personal scope
(1) Except as otherwise provided in this Convention, this Convention shall apply to persons who are residents of one or both of the Contracting States.
As a general matter only residents of the US or Australia may claim the benefits of the Convention.
Apart from the introductory exception, Art 1(1) of the Convention corresponds with Art 1 of the OECD Model.
The OECD Commentary on Art 1 of the OECD Model, under the heading: Application of the Convention to partnerships, relevantly reads:
2. Domestic laws differ in the treatment of partnerships. These differences create various difficulties when applying tax Conventions in relation to partnerships…
(Replaced on 29 April 2000; see HISTORY)
3. … a main source of difficulties is the fact that some countries treat partnerships as taxable units (sometimes even as companies) whereas other countries adopt what may be referred to as the fiscally transparent approach, under which the partnership is ignored for tax purposes and the individual partners are taxed on their respective share of the partnership’s income.
(Replaced on 29 April 2000; see HISTORY)
4. A first difficulty is the extent to which a partnership is entitled as such to the benefits of the provisions of the Convention. Under Article 1, only persons who are residents of the Contracting States are entitled to the benefits of the tax Convention entered into by these States. While paragraph 2 of the Commentary on Article 1 explains why a partnership constitutes a person, a partnership does not necessarily qualify as a resident of a Contracting State under Article 4.
(Replaced on 29 April 2000; see HISTORY)
5. Where a partnership is treated as a company or taxed in the same way, it is a resident of the Contracting State that taxes the partnership on the grounds mentioned in paragraph 1 of Article 4 and, therefore, it is entitled to the benefits of the Convention. Where, however, a partnership is treated as fiscally transparent in a State, the partnership is not “liable to tax” in that State within the meaning of paragraph 1 of Article 4, and so cannot be a resident thereof for purposes of the Convention. In such a case, the application of the Convention to the partnership as such would be refused, unless a special rule covering partnerships were provided for in the Convention. Where the application of the Convention is so refused, the partners should be entitled, with respect to their share of the income of the partnership, to the benefits provided by the Conventions entered into by the States of which they are residents to the extent that the partnership’s income is allocated to them for the purposes of taxation in their State of residence (see paragraph 8.4 of the Commentary on Article 4).
(Replaced on 29 April 2000; see HISTORY)
6. The relationship between the partnership’s entitlement to the benefits of a tax Convention and that of the partners raises other questions.
(Replaced on 29 April 2000; see HISTORY)
6.1 One issue is the effect that the application of the provisions of the Convention to a partnership can have on the taxation of the partners. Where a partnership is treated as a resident of a Contracting State, the provisions of the Convention that restrict the other Contracting State’s right to tax the partnership on its income do not apply to restrict that other State’s right to tax the partners who are its own residents on their share of the income of the partnership. Some states may wish to include in their conventions a provision that expressly confirms a Contracting State’s right to tax resident partners on their share of the income of a partnership that is treated as a resident of the other State.
(Added on 29 April 2000; see HISTORY)
6.2 Another issue is that of the effect of the provisions of the Convention on a Contracting State’s right to tax income arising on its territory where the entitlement to the benefits of one, or more than one, Conventions is different for the partners and the partnership. Where, for instance, the State of source treats a domestic partnership as fiscally transparent and therefore taxes the partners on their share of the income of the partnership, a partner that is resident of a State that taxes partnerships as companies would not be able to claim the benefits of the Convention between the two States with respect to the share of the partnership’s income that the State of source taxes in his hands since that income, though allocated to the person claiming the benefits of the Convention under the laws of the State of source, is not similarly allocated for purposes of determining the liability to tax on that item of income in the State of residence of that person.
(Added on 29 April 2000; see HISTORY)
6.3 The results described in the preceding paragraph should obtain even if, as a matter of the domestic law of the State of source, the partnership would not be regarded as transparent for tax purposes but as a separate taxable entity to which the income would be attributed, provided that the partnership is not actually considered as a resident of the State of source. This conclusion is founded upon the principle that the State of source should take into account, as part of the factual context in which the Convention is to be applied, the way in which an item of income, arising in its jurisdiction, is treated in the jurisdiction of the person claiming the benefits of the Convention as a resident. For States which could not agree with this interpretation of the Article, it would be possible to provide for this result in a special provision which would avoid the resulting potential double taxation where the income of the partnership is differently allocated by the two States.
(Added on 29 April 2000; see HISTORY)
6.4 Where, as described in paragraph 6.2, income has “flowed through” a transparent partnership to the partners who are liable to tax on that income in the State of their residence then the income is appropriately viewed as “paid” to the partners since it is to them and not to the partnership that the income is allocated for purposes of determining their tax liability in their State of residence. Hence the partners, in these circumstances, satisfy the condition, imposed in several Articles, that the income concerned is “paid to a resident of the other Contracting State”. Similarly the requirement, imposed by some other Articles, that income or gains are “derived by a resident of the other Contracting State” is met in the circumstances described above. This interpretation avoids denying the benefits of tax Conventions to a partnership’s income on the basis that neither the partnership, because it is not a resident, nor the partners, because the income is not directly paid to them or derived by them, can claim the benefits of the Convention with respect to that income. Following from the principle discussed in paragraph 6.3, the conditions that the income be paid to, or derived by, a resident should be considered to be satisfied even where, as a matter of the domestic law of the State of source, the partnership would not be regarded as transparent for tax purposes, provided that the partnership is not actually considered as a resident of the State of source.
(Added on 29 April 2000; see HISTORY)
6.5 Partnership cases involving three States pose difficult problems with respect to the determination of entitlement to benefits under Conventions. However, many problems may be solved through the application of the principles described in paragraphs 6.2 to 6.4. Where a partner is a resident of one State, the partnership is established in another State and the partner shares in partnership income arising in a third State then the partner may claim the benefits of the Convention between his State of residence and the State of source of the income to the extent that the partnership’s income is allocated to him for the purposes of taxation in his State of residence. If, in addition, the partnership is taxed as a resident of the State in which it is established then the partnership may itself claim the benefits of the Convention between the State in which it is established and the State of source. In such a case of “double benefits”, the State of source may not impose taxation which is inconsistent with the terms of either applicable Convention; therefore, where different rates are provided for in the two Conventions, the lower will be applied. However, Contracting States may wish to consider special provisions to deal with the administration of benefits under Conventions in situations such as these, so that the partnership may claim benefits but partners could not present concurrent claims. Such provisions could ensure appropriate and simplified administration of the giving of benefits. No benefits will be available under the Convention between the State in which the partnership is established and the State of source if the partnership is regarded as transparent for tax purposes by the State in which it is established. Similarly no benefits will be available under the Convention between the State of residence of the partner and the State of source if the income of the partnership is not allocated to the partner under the taxation law of the State of residence. If the partnership is regarded as transparent for tax purposes by the State in which it is established and the income of the partnership is not allocated to the partner under the taxation law of the State of residence of the partner, the State of source may tax partnership income allocable to the partner without restriction.
(Added on 29 April 2000; see HISTORY)
6.6 Differences in how countries apply the fiscally transparent approach may create other difficulties for the application of tax Conventions. Where a State considers that a partnership does not qualify as a resident of a Contracting State because it is not liable to tax and the partners are liable to tax in their State of residence on their share of the partnership’s income, it is expected that that State will apply the provisions of the Convention as if the partners had earned the income directly so that the classification of the income for purposes of the allocative rules of Articles 6 to 21 will not be modified by the fact that the income flows through the partnership. Difficulties may arise, however, in the application of provisions which refer to the activities of the taxpayer, the nature of the taxpayer, the relationship between the taxpayer and another party to a transaction. Some of these difficulties are discussed in paragraph 19.1 of the Commentary on Article 5 and paragraphs 6.1 and 6.2 of the Commentary on Article 15.
(Added on 29 April 2000; see HISTORY)
6.7 Finally, a number of other difficulties arise where different rules of the Convention are applied by the Contracting States to income derived by a partnership or its partners, depending on the domestic laws of these States or their interpretation of the provisions of the Convention or of the relevant facts. These difficulties relate to the broader issue of conflicts of qualification, which is dealt with in paragraphs 32.1 ff. and 56.1 ff. of the Commentary on Article 23.
(Added on 29 April 2000; see HISTORY)
(Emphasis added)
Article 3 relevantly provides:
ARTICLE 3
General definitions
(1) For the purposes of this Convention, unless the context otherwise requires:
(a)the term “person” includes an individual, an estate of a deceased individual, a trust, a partnership, a company and any other body of persons;
It is common ground that RCF is a person for the purposes of the Convention.
Article 4 relevantly provides:
ARTICLE 4
Residence
(1) For the purposes of this Convention:
…
(b) a person is a resident of the United States if the person is:
(i) a United States corporation;
(ii)…; or
(iii)any other person (except a corporation or unincorporated entity treated as a corporation for United States tax purposes) resident in the United States for purposes of its tax, provided that, in relation to any income derived by a partnership, an estate of a deceased individual or a trust, such person shall not be treated as a resident of the United States except to the extent that the income is subject to United States tax as the income of a resident, either in its hands or in the hands of a partner or beneficiary, or, if that income is exempt from United States tax, is exempt other than because such person, partner or beneficiary is not a United States person according to United States law relating to United States tax.
(Emphasis added)
Under Art II(1)(g) of the 1953 Convention, a partnership created or organised in or under the laws of the US (a US domestic partnership) was a resident of the US for the purposes of the 1953 Convention whether or not the partners were liable to US tax on the income of the partnership. If the partners in the US domestic partnership were foreign companies (i.e., incorporated outside the United States) and the partnership income was not effectively connected with the conduct of a trade or business carried on in the US, neither the partnership (because it was fiscally transparent) nor the partners would be liable to US tax on the partnership income, but because the partnership was a resident of the US for the purposes of the 1953 Convention, it was entitled to the benefits of the 1953 Convention vis-à-vis Australian source income. The negotiators of the Convention were conscious of this anomaly when drafting Art 4(1)(b)(iii); thus, under the Convention, even a US domestic partnership will only be a resident of the US for the purposes of the Convention to the extent that the income of the partnership is subject to US tax in the hands of a partner or, if that income is exempt from US tax, is exempt other than because such partner is not a US person according to US law relating to US tax.
Article 7 relevantly provides:
ARTICLE 7
Business Profits
(1) The business profits of an enterprise of one of the Contracting States shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the business profits of the enterprise may be taxed in the other State but only so much of them as is attributable to that permanent establishment.
…
(6) Where business profits include items of income which are dealt with separately in other Articles of this Convention, then the provisions of those Articles shall not be affected by the provisions of this Article.
…
(9) Where:
(a)a resident of one of the Contracting States is beneficially entitled, whether directly or through one or more interposed fiscally transparent entities, to a share of the business profits of an enterprise carried on in the other Contracting State by the fiscally transparent entity, (or, in the case of a trust, by the trustee of the trust estate); and
(b)in relation to that enterprise, that fiscally transparent entity (or trustee) would, in accordance with the principles of Article 5 (Permanent Establishment), have a permanent establishment in that other State, that enterprise carried on by that fiscally transparent entity (or trustee) shall be deemed to be a business carried on in the other State by that resident through a permanent establishment situated in that other State and that share of business profits shall be attributed to that permanent establishment.
Article 13 relevantly provides:
ARTICLE 13
Alienation of property
(1) Income or gains derived by a resident of one of the Contracting States from the alienation or disposition of real property situated in the other Contracting State may be taxed in that other State.
(2) For the purposes of this Article:
…
(b)the term “real property”, in the case of Australia, shall have the meaning which it has under the laws in force from time to time in Australia and, without limiting the foregoing, includes:
(i) real property referred to in Article 6;
(ii)shares or comparable interests in a company, the assets of which consist wholly or principally of real property situated in Australia; and
(iii)an interest in a partnership, trust or estate of a deceased individual, the assets of which consist wholly or principally of real property situated in Australia.
…
(7) Except as provided in the preceding paragraphs of this Article, each Contracting State may tax capital gains in accordance with the provisions of its domestic law; and
(8) For the purposes of this Article, real property consisting of shares in a company referred to in sub-paragraph (2)(b)(ii), and interests in a partnership, trust or estate referred to in sub-paragraph (2)(b)(iii), shall be deemed to be situated in Australia.
General Principles of Interpretation of Double Tax Treaties
In Virgin Holdings SA v Commissioner of Taxation (2008) 70 ATR 478 I set out (at [19] to [24]) the general principles for the interpretation of double tax treaties to which Australia is a party, as enunciated by the High Court in cases such as Thiel v Federal Commissioner of Taxation (1990) 171 CLR 338; by McHugh J (with Brennan CJ’s agreement) in Applicant A v Minister for Immigration and Ethnic Affairs (1997) 190 CLR 225; and embraced by full courts of this Court in cases such as Federal Commissioner of Taxation v Lamesa Holdings BV (1997) 77 FCR 597 and McDermott Industries (Aust) Pty Ltd v Federal Commissioner of Taxation (2005) 142 FCR 134.
I said:
[19] The starting point for any consideration of the relevant principles of interpretation of double tax treaties is the Vienna Convention on the Law of Treaties [1974] ATS 2 (the Vienna Convention), to which Australia is a party. In Thiel (at CLR 356; ATR 541-542; ALJR 523; ATC 4726-4727; ALR 658-659), McHugh J said:
“The [Swiss Agreement] is a treaty and is to be interpreted in accordance with the rules of interpretation recognised by international lawyers: Shipping Corporation of India Ltd v Gamlen Chemical Co. (A/Asia) Pty Ltd (1980) 147 CLR 142 at 159. Those rules have now been codified by the Vienna Convention on the Law of Treaties to which Australia, but not Switzerland, is a party. Nevertheless, because the interpretation provisions of the Vienna Convention reflect the customary rules for the interpretation of treaties, it is proper to have regard to the terms of the Convention in interpreting the Agreement, even though Switzerland is not a party to that Convention: Fothergill v Monarch Airlines Ltd [1981] AC 251 at 276, 282, 290; Commonwealth v Tasmania (Tasmanian Dam case) (1983) 158 CLR 1 at 222; Golder v United Kingdom (1975) 57 ILR 201 at 213-214 .”
[20] Articles 31 and 32 of the Vienna Convention provides:
Article 31: General rule of interpretation
(1)A treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to terms of the treaty in their context and in the light of its object and purpose;
(2)The context for the purpose of the interpretation of a treaty shall comprise, in addition to the text, including its preamble and annexes:
(a)any agreement relating to the treaty which was made between all the parties in connection with the conclusion of the treaty;
(b)any instrument which was made by one or more parties in connection with the conclusion of the treaty and accepted by the other parties as an instrument related to the treaty.
(3)There shall be taken into account, together with the context:
(a)any subsequent agreement between the parties regarding the interpretation of the treaty or the application of its provisions;
(b)any subsequent practice in the application of the treaty which establishes the agreement of the parties relating to its interpretation;
(c)any relevant rules of international law applicable in the relations between the parties.
(4)A special meaning shall be given to a term if it is established that the parties so intended.
Article 32: Supplementary means of interpretation
Recourse may be had to supplementary means of interpretation, including the preparatory work of the treaty and the circumstances of its conclusion, in order to confirm the meaning resulting from the application of Article 31, or to determine the meaning when the interpretation according to Article 31:
(a) leaves the meaning ambiguous or obscure; or
(b) leads to a result which is manifestly absurd or unreasonable.
[21] In Thiel (at CLR 356-357; ATR 542; ALJR 523; ATC 4727; ALR 659), McHugh J said of these articles:
Article 31 of the Convention requires a treaty to be interpreted in accordance with the ordinary meaning to be given to its terms “in their context and in the light of its object and purpose”. The context includes the preamble and annexes to the treaty (art 31(2)). Recourse may also be had to “supplementary means of interpretation, including the preparatory work of the treaty and the circumstances of its conclusion” to confirm the meaning resulting from the application of art 31 or to determine the meaning of the treaty when interpretation according to art 31 leaves its meaning obscure or ambiguous or leads to a result which is manifestly absurd or unreasonable (art 32).
[22] In Applicant A v Minister for Immigration and Ethnic Affairs (1997) 190 CLR 225; 71 ALJR 381; 142 ALR 331, in the context of considering the meaning of a term in a domestic statute defined by reference to its meaning in an international treaty (at CLR 254-256; ALJR 396-397; ALR 351-353) McHugh J laid down, in a succinct form, the principles which govern the interpretation of a treaty, principles with which Brennan CJ (at 230) respectfully agreed:
First, … art 31 [of the Vienna Convention] is to be interpreted in a holistic manner. …
Secondly … the text of the treaty, being the starting point in any investigation as to the meaning of the text, necessarily has primacy in the interpretation process … [as] “the authentic expression of the intentions of the parties.”
Thirdly, the mandatory requirement that courts look to the context, object and purpose of treaty provisions as well as the text is consistent with the general principle that international instruments should be interpreted in a more liberal manner than would be adopted if the court was required to construe exclusively domestic legislation.
Fourthly, international treaties often fail to exhibit the precision of domestic legislation. This is the sometimes necessary price paid for multinational political comity. …
Accordingly, in my opinion, art 31 of the Vienna Convention requires the courts of this country when faced with a question of treaty interpretation to examine both the “ordinary meaning” and the “context … object and purpose” of a treaty.
[23] These principles were embraced by full courts of this court in FCT v Lamesa Holdings BV (1997) 77 FCR 597 at 604D-605G; 36 ATR 589 at 595-597; 97 ATC 4752 at 4758–4759; 157 ALR 290 at 296–297 and in McDermott Industries (Aust) Pty Ltd v FCT (2005) 142 FCR 134 at 143 [37]-[38]; 59 ATR 358 at 595-597 [37]-[38]; 2005 ATC 4398 at 4405–4406 [37]–[38]; 219 ALR 346 at 355 [37]–[38]..
[24] Finally, it is to be noted that in Thiel (at CLR 357; ATR 542; ALJR 523; ATC 4727; ALR 659), McHugh J was of the view that the supplementary materials (referred to in art 32 of the Vienna Convention) relevant to the Swiss Agreement were the 1977 OECD Model Convention for the Avoidance of Double Taxation with respect to Taxes on Income and on Capital (the Model Convention), which was the model for the Swiss Agreement, and the commentary issued by the OECD in relation to that Model Convention (Model commentary). Mason CJ, Brennan and Gaudron JJ agreed that it was appropriate to have regard to that material (at CLR 344; ATR 533-534; ALJR 517; ATC 4719; ALR 649-650) as did Dawson J (at CLR 349-350; ATR 536-538; ALJR 519-520; ATC 4722-4724; ALR 653-654).
In my view, nothing has occurred in the intervening period between then and now to put these principles in doubt. Nevertheless, the Commissioner, in his written submissions, cast doubt on the reliance that could be placed on supplementary materials (referred to in Art 32 of the Vienna Convention on the Law of Treaties [1974] ATS 2 (“Vienna Convention”)) such as the commentary issued by the Organisation for Economic Co-Operation and Development (OECD) on its Model Taxation Convention, by reference to what was said by Dowsett J in Russell v Federal Commissioner of Taxation (2011) 190 FCR 449 at [25] to [31] where his Honour relevantly said:
[25] The primary judge observed that the NZ Agreement generally followed the OECD model and that:
It is settled that, in construing such an agreement, a court may have regard to, inter alia, the OECD commentary on its model agreement …
[26] The decision in Thiel is quoted as authority for this proposition. Reference is also made to the decision of the Full Court in McDermott Industries (Aust) Pty Ltd v Federal Commissioner of Taxation (2005) 142 FCR 134 at [42]. It is certainly true that in both cases, reference was made to such commentary. However both of those cases were decided prior to the decisions of the High Court in Minister for Immigration and Multicultural and Indigenous Affairs v QAAH of 2004 (2006) 231 CLR 1 and NBGM v Minister for Immigration and Multicultural Affairs (2006) 231 CLR 52. In both cases the Court emphasized the primary position of the words used in Australian legislation and the Australian rules of statutory interpretation in construing legislation which gives effect to international obligations, including treaties. …
…
[30] Whilst I remain bound by the actual decision in Thiel, the approach adopted in QAAH and NBGM appears to require care in referring to material concerning international instruments. I see no reason for applying a different approach to model agreements. The approach is of some importance in the present case. Mr Russell’s primary criticism of the decision is that his Honour relied upon “OECD rulings or pronouncements”. …
[31] I do not accept that the primary judge's consideration of the NZ Agreement focused upon the material concerning the OECD model to the exclusion of the wording of the Tax Agreements Act and the NZ Agreement. At [120] his Honour records his view as to the effect of the wording of the NZ Agreement. In subsequent paragraphs he discusses the international material, concluding that it supports that view. …
This passage from his Honour’s reasons has to be read and understood in context. It was written in response to the appellant’s criticism of the approach of the primary judge below: that the primary judge relied on the OECD commentary to its model agreement to override the terms of the Agreements Act, including the New Zealand Agreement. Dowsett J did not accept that criticism and while suggesting that care needed to be taken in referring to such supplementary materials, concluded that the primary judge used the supplementary materials to support his analysis as to the effect of the wording of the New Zealand Agreement. Dowsett J proceeded to focus upon the terms of the Agreements Act, including the New Zealand Agreement, more out of deference to the appellant’s criticism of the primary judge; but certainly not out of rejection of the principles of interpretation arising out of Thiel.
This was subsequently confirmed by a Full Court in Federal Commissioner of Taxation v SNF (Australia) Pty Ltd (2011) 193 FCR 149 at [119] and [120]:
[119] [I]t is crucial to observe that the whole text of each treaty has been given domestic effect. In cases where the exact text of a whole treaty has been given effect by domestic legislation it would be surprising if it were interpreted without keeping that fact in mind. It should be noted that these taxation treaties stand in a very different position to, for example, the Refugee Conventions whose text is not given the force of law. Where Parliament implements a treaty using its expressions and its provisions then naturally enough one must begin with the words Parliament has used. But where Parliament expressly decides to incorporate the whole text of a treaty in domestic law and makes it plain, as here, that it is doing so, then it is appropriate to construe the provisions in accordance with the ordinary principles governing the interpretation of treaties. This is because the Parliament's use of the treaty shows its intention to fulfil its international obligations. This has been accepted by the High Court in respect of the double taxation treaties: Thiel.
[120] This conclusion is unsurprising. The double taxation treaties are designed to ensure that the taxing regimes of two jurisdictions do not result in double taxation. If they were to be interpreted in a manner which would permit or foster conflicting outcomes between the two States in question their whole point would be frustrated. It is true, as Dowsett J has observed in Russell at [26]-[29], that the High Court has indicated in the context of the Refugee Conventions that domestic courts must recall that their task is to interpret the Migration Act 1958 (Cth) and not the Conventions. But, unlike the present legislation, that Act does not adopt and apply the whole text of a treaty. When a State decides to implement, as it has in this case, a Model Law, it would be quite inappropriate to disregard that fact when construing the resultant statute.
Finally, the Commissioner referred to what was said by the plurality in Minister for Home Affairs v Zentai (2012) 289 ALR 644. At [65] their Honours said:
The meaning of the limitation set out in Art 2.5(a) [of the Treaty on Extradition between Australia and the Republic of Hungary] is to be ascertained by the application of ordinary principles of statutory interpretation.101
The authorities referred to at footnote 101 – Project Blue Sky Inc v Australian Broadcasting Authority (1998) 194 CLR 355 at [69] per McHugh, Gummow, Kirby and Hayne JJ and Alcan (NT) Alumina Pty Ltd v Commissioner of Territory Revenue (2009) 239 CLR 27 at [47] per Hayne, Heydon, Crennan and Kiefel JJ – state what the task of the ordinary principles of statutory construction involve: the clear meaning of the text to prevail over historical considerations and extrinsic materials (see too more recently Commissioner of Taxation v Consolidated Media Ltd [2012] HCA 55 at [39]), but where necessary, assistance can be drawn by consideration of the context which includes general purpose and policy of a provision, in particular the mischief it is seeking to remedy.
However, I do not regard this sentence on a stand-alone basis as a rejection of the general principles of interpretation of double tax treaties coming out of Thiel, the other cases referred to in [46] above and the passage from the Full Court’s reasons in SNF extracted in [50] above.
Support for this view is to be found in the reasons of the Chief Justice. French CJ came to the same conclusion as the plurality by recourse to the correct principles of construction starting with Arts 31 and 32 of the Vienna Convention and referring to the principles embraced by Dawson J and McHugh J (with whom Brennan CJ agreed) in Applicant A. In Zentai, the Chief Justice said at [19]:
The rules of interpretation in Arts 31 and 32 have been said to represent customary international law [Sovereignty Over Pulau Ligitan and Pulau Sipadan (Indonesia v Malaysia) (Judgement) [2002] ICJ Rep 625 at 645]. Whether or not they are or have been adopted as part of the common law of Australia, those rules are generally consistent with the common law. [As to the relationship between customary international law and the common law, see Chow Hung Ching v R (1948) 77 CLR 449 at 462 per Latham CJ, 471 per Starke J, cf at 477 per Dixon J.] The common law requires treaties to be construed “unconstrained by technical rules of English law, or by English legal precedent, but on broad principles of general acceptation”. [Shipping Corporation of India Ltd v Gamlen Chemical Co A/Asia Pty Ltd (1980) 147 CLR 142 at 159 per Mason and Wilson JJ, Gibbs J agreeing at 149, … Aickin J agreeing at 168, citing James Buchanan & Co Ltd v Babco Forwarding & Shipping (UK) Ltd [1978] AC 141 at 152 … per Lord Wilberforce. See also Chan v Minister for Immigration and Ethnic Affairs (1989) 169 CLR 379 at 413 per Gaudron J.] That was the approach adopted by Dawson J in Applicant A v Minister for Immigration and Ethnic Affairs [(1997) 190 CLR 225 at 240; [1997] HCA 4] who observed that:
Article 31 plainly precludes the adoption of a literal construction which would defeat the object or purpose of a treaty and be inconsistent with the context in which the words being construed appear.
McHugh J, with whom Brennan CJ agreed in this respect [(1997) 190 CLR 225 at 231], said the correct approach to Art 31 was “a single combined operation which takes into account all relevant facts as a whole.” [(1997) 190 CLR 225 at 254, citing Judge Zekia in Golder v United Kingdom (1975) 1 EHRR 524 at 544. See also The Commonwealth v Tasmania (The Tasmanian Dam Case) (1983) 158 CLR 1 at 177 per Murphy J; Riley v The Commonwealth (1985) 159 CLR 1 at 15 per Deane J; Thiel v Federal Commissioner of Taxation (1990) 171 CLR 338 at 349 per Dawson J, 356–357 per McHugh J; Victoria v The Commonwealth (Industrial Relations Act Case) (1996) 187 CLR 416 at 545-546 per Brennan CJ, Toohey, Gaudron, McHugh and Gummow JJ; Oates v Attorney-General (Cth) (2003) 214 CLR 496 at 512 [43] per Gleeson CJ, McHugh, Gummow, Kirby, Hayne and Heydon JJ.] It is that approach which is appropriate to the construction of Art 2.5(a) of the treaty.
Consideration and Analysis
Various underlying issues were said to be relevant to the resolution of the first issue – the treaty issue – and were the subject of extensive submissions from both parties in the form of reports from H David Rosenbloom, Professor of Taxation and the Director of the International Tax Program at New York University School of Law on behalf of RCF, and David T Moldenhauer, an adjunct professor of international tax in the Graduate Tax Program of New York Law School on behalf of the Commissioner. These reports were originally intended to be put into evidence but the parties agreed that they were inadmissible, as they contained application evidence which could not be disentangled from evidence about the law in the US. The parties agreed that the Court could have regard to the reports as or by way of submission and that relevant underlying statutory and other material referred to in the reports would be tendered.
Is RCF a resident of the US for the purposes of the Convention?
One underlying issue on which the parties parted company was whether RCF was a resident of the US for the purposes of the Convention. The Commissioner submitted that ultimately it does not matter in the present case if RCF is a resident within the meaning of Art 4(1)(b)(iii) of the Convention or not, a proposition with which, for reasons developed later, I agree (see [68] below). On the other hand, the Commissioner’s reasons underlying the proposition, namely, because the relevant taxing article in the Convention (Art 13) gives Australia unlimited taxing rights must, for reasons which I will also develop later, be rejected (see [63] below).
The Commissioner’s “preferred” position on this issue is that RCF was a resident of the US for the purposes of the Convention in the year of income. To this end, the Commissioner submitted that Art 4(1)(b)(iii) of the Convention should not be read as literally requiring that partnerships must be recognised by the US as a resident separate from the requirement that income of the partnership must be taxed in the hands of a US resident partner, as such a requirement would defeat the clear intention of the Convention to recognise partnerships as being capable of being “residents” for treaty purposes. The reason for this, according to the Commissioner, is because there is no principle of US tax law that a partnership’s residence is based on where it is organised.
RCF submitted that it was neither appropriate nor permissible to ignore the words “resident in the United States for purposes of its tax” in Art 4(1)(b)(iii) of the Convention and that there was a dual requirement to be satisfied before a partnership could qualify as a resident of the US for the purposes of the Convention: first, the partnership had to be resident in the US for the purposes of its tax; and second, the income of the partnership had to be subject to US tax as the income of a resident partner, or be exempt from US tax in the hands of a resident partner.
RCF submitted that it would fail the first requirement: being a foreign partnership, it was not resident in the US for the purposes of its tax notwithstanding that all or substantially all of the partners were resident in the US and liable to or exempt from US tax on their distributive shares of such income. The basis of RCF’s submission that it was not resident in the US for the purposes of its tax went like this: the domestic/foreign classification test for partnerships is the same as it is for companies: IRC §§ 7701(a)(4), 7701(a)(5). The Report of the US Senate Foreign Relations Committee on the Convention states, in summarising Art 4 (see [42] above), that “a company is resident in the United States if it is organised in the United States”. RCF submitted that the implication of this statement, in context, is that a company that is not organised in the US is not resident in the US. Since partnerships and corporations are subject to the same Internal Revenue Code classification test for whether they are domestic or foreign, RCF further submitted that there is no reason for partnerships to be subject to a different test than corporations for whether they are resident in the US. On this basis, RCF would not be resident in the US for US tax purposes because it was organised under the laws of the Cayman Islands.
RCF’s submission is certainly consistent with the position which prevailed under the 1953 Convention (see [43] above); only a partnership created or organised in or under the laws of the US qualified as a resident of the US for the purposes of the 1953 Convention. Implicit in that was that such a partnership was resident in the US for US tax purposes and a foreign partnership, such as RCF, was not.
Having regard to this last mentioned consideration, I am of the view that RCF’s submissions on this issue are to be preferred to the Commissioner’s: first, that Art 4(1)(b)(iii) of the Convention does impose a dual requirement to be satisfied before a partnership can qualify as a resident of the US for the purposes of the Convention; second, that RCF is not resident in the US for the purposes of its tax; and third, it follows that RCF is not a resident of the US for the purposes of the Convention.
Does Art 13 of the Convention apply to authorise Australia to tax the gain to RCF?
Article 13 authorises taxation of “gains derived by a resident of one of the Contracting States from the alienation or disposition of real property situated in the other Contracting State” (Art 13(1)), including the disposal of shares “in a company, the assets of which consist wholly or principally of real property situated in Australia” (Art 13(2)(b)(ii)), but does not authorise taxation of a gain not made by a resident of one of the Contracting States.
As RCF, on my view, is not resident in the US for the purposes of its tax and therefore is not a resident of the US for the purposes of the Convention, Art 13 does not authorise Australia to tax the gain to RCF.
But the Commissioner points to para (7) of Art 13, which states that, except as provided in the preceding paragraphs, each Contracting State may tax capital gains in accordance with its domestic law. The Commissioner submitted that because the Convention grants primary taxing authority over capital gains to the source Contracting State, in this case Australia, the Convention has no further role. This view rests upon the Commissioner’s observation that the wording of para (7) is broad enough to cover gains of every type, including gains from the disposition of real property. In my view, para (7) does not put a Contracting State at large to tax capital gains in accordance with its domestic law. Paragraph (7) is limited by the context in which it appears. First, it does not apply to authorise Australia to tax capital gains from the disposition of “real property” as defined in para (2)(b), otherwise para (1) would be unnecessary. Second, it only authorises Australian taxation of capital gains derived by a resident of the US for the purposes of the Convention and, as reasoned in [55] to [60] above, RCF is not a resident of the US for the purposes of the Convention. Support for such limitation is to be found in the observation in [2.84] of the Explanatory Memorandum to the International Tax Agreements Amendment Bill (No 1) 2002 which, when enacted, facilitated the entry into force of the 2001 Protocol that, by para (7):
Australia will…continue to be able to tax, for instance, capital gains derived by US residents on the disposal of Australian entities.
(Emphasis added.)Who derived the gain for the purposes of the Convention?
Consistent with the principles of interpretation that come out of Thiel and the cases referred to in [46] above, and those extracted in Virgin Holdings at [19] to [24] inclusive ([47]) above), in particular at [24], “[r]ecourse may be had to supplementary means of interpretation” (Article 32 of the Vienna Convention) in order to confirm the meaning resulting from “the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object and purpose” (Article 31(1) of the Vienna Convention); embracing as it does, in the case of a double taxation treaty to which Australia is a party, such as the Swiss Agreement in Thiel, and the Convention in the present case, the OECD Model and the OECD Commentary thereon.
RCF is fiscally transparent for US tax purposes and the limited partners are subject to US tax on RCF’s income. The OECD Commentary on Art 1 of the OECD Model (which, as noted in [38] above, substantially corresponds with Article 1(1) of the Convention) provides that when partners are liable to tax in the country of their residence on their share of partnership income it is expected that the source country, (in this case, Australia) will apply the provisions of a convention –
… as if the partners had earned the income directly so that the classification of the income for purposes of the allocative rules of Articles 6 to 21 will not be modified by the fact that the income flows through the partnership.
(OECD Commentary on Art 1, para 6.6).
Thus, the requirement, imposed by Art 13 of the Convention, that income or gains derived by a resident of one of the Contracting States (US) from the alienation or disposition of real property situated in the other Contracting State (Australia) may be taxed in the other State, is met in the circumstances of the present case by treating the gain as having been derived not by RCF but by its limited partners who or which are residents of the US for the purposes of the Convention.
This interpretation avoids denying the benefits of tax Conventions to a partnership’s income on the basis that neither the partnership, because it is not a resident, nor the partners, because the income is not directly paid to them or derived by them, can claim the benefits of the Convention with respect to that income. Following from the principle discussed in paragraph 6.3, the conditions that the income be paid to, or derived by, a resident should be considered to be satisfied even where, as a matter of the domestic law of the State of source, the partnership would not be regarded as transparent for tax purposes, provided that the partnership is not actually considered as a resident of the State of source.
(OECD Commentary on Art 1, para 6.4).
Here, RCF was not a resident of Australia for the purposes of the Convention in the year of income and while the Assessment Acts regarded RCF as not being transparent, the OECD Commentary on Art 1 of the OECD Model –
…is founded upon the principle that the State of source (Australia) should take into account, as part of the factual context in which the Convention is to be applied, the way in which an item of income, arising in its jurisdiction, is treated in the jurisdiction of the person claiming the benefits of the Convention as a resident.
(OECD Commentary on Art 1, para 6.3).
This same approach and conclusion would be reached even if RCF was a resident in the US for the purposes of its tax and therefore a resident of the US for the purposes of the Convention under Art 4(1)(b)(iii) because it would, nevertheless, be fiscally transparent under US law with the liability for tax falling on the limited partners. So much explains my agreement with the Commissioner’s submission recorded in [55] above that ultimately it does not matter in the present case if RCF is resident within the meaning of Art 4(1)(b)(iii) or not. It is the limited partners of RCF, not RCF the limited partnership, that Australia is authorised to tax under Art 13(1) of the Convention.
At [29] above I made the trite observation that the purpose of the Convention is to avoid the double taxation of the income of residents of the US and Australia. This policy objective was repeated, but specifically in relation to the prevention of the double taxation of capital gains, in [4.41] of the Explanatory Memorandum to the Bill referred to in [63] above which, when enacted, facilitated the entry into force of the 2001 Protocol. Under the heading “Specification of policy objective”, it reads:
The key objective in updating Australia’s tax treaty with the United States is to make a significant advance in providing a competitive tax treaty network for companies located in Australia by reducing the rate of DWT on US subsidiaries and branches of Australian companies. An important secondary goal is to prevent double taxation of capital gains derived by US residents on the disposal of interests in Australian entities while retaining Australian taxing rights.
(Emphasis added.)That policy objective will not be achieved if Australia is authorised under Article 13(1), or is otherwise at large under Article 13(7), of the Convention, to tax the gain to RCF the limited partnership. The US resident limited partners will be liable to US tax on a capital gain without credit for the Australian tax assessed to RCF on the gain. On the other hand, by authorising Australia to tax a gain in the hands of the US resident limited partners, the Convention recognises Australia’s taxing right, but at the same time provides in Article 22(1) a credit for any Australian tax suffered as a result of the exercise of that right and so prevents double taxation of the gain. In short, the policy objective is achieved rather than being frustrated as under the position contended for by the Commissioner in the present case.
No Reservations to OECD Commentary
The OECD Commentary on Art 1 of the OECD Model extracted in [39] above, had been incorporated from the report adopted by the OECD Committee on Fiscal Affairs on 20 January 1999 entitled: “The Application of the OECD Model Tax Convention to Partnerships”, by the time of the signing of the 2001 Protocol. Neither the US nor Australia expressed any reservation as to its incorporation.
RCF Submissions
RCF submitted that from the perspective of US law such an approach, namely, that for the purposes of the Convention, the gain was derived by the limited partners in RCF which, by Art 13(1) of the Convention, Australia was authorised to tax, if at all, in their hands and not in the hands of RCF the limited partnership, would be consistent with other provisions of the Convention and US treaty policy generally.
An example proffered was para (9) of Art 7 of the Convention which provides that when a resident of a Contracting State is beneficially entitled to a share of the business profits of an entity that is treated as fiscally transparent, it is “deemed to be a business carried on” by the resident. RCF submitted that a US court would find that the purpose of that provision was to establish who should be viewed as conducting the activities of the fiscally transparent entity. So much would seem to be beyond argument. RCF further submitted that a US court would construe the Convention as deeming the partner to be conducting those activities, not the partnership. So would, in my view, an Australian court. Finally, RCF submitted that attributing to a partner activities conducted by the partnership is consistent with the view that partners hold shares owned by a partnership for capital gains purposes. I agree.
Another example proffered was Art 10 of the Convention. The Technical Explanation 2001, discussing Art 10 of the Convention, provides that “[c]ompanies holding shares through fiscally transparent entities such as partnerships are considered for purposes of this paragraph to hold their proportionate interest in the shares held by the intermediate entity (Technical Explanation 2001, Art 6). This is consistent with the US position that ownership measurement is performed on a look-through basis: Richard E Andersen, Analysis of United States Income Tax Treaties, 2.01[3][b][vi]. Dividends and capital gains both reflect returns to shareholders on investments. RCF submitted that through share redemption a return of undistributed earnings of a corporation could easily be structured as a capital gain, at least for US tax purposes. RCF further submitted that a provision identifying proportionate share ownership for dividend purposes would be considered by a US court to be highly influential in determining how capital gains arising through fiscally transparent entities should be characterised for purposes of the Convention.
Nor, submitted RCF, has there been any reversal in treaty policy under the US Model Income Tax Convention of November 15, 2006 (“US Model”). Under the US Model a look-through approach is, according to RCF, still used for the purpose of determining who derives income through a fiscally transparent entity. Certainly, there has been no shift from the position that, for treaty purposes, a partner in a fiscally transparent entity derives income and owns its proportionate share of stock held by the entity.
Finally, in a mirror transaction involving Australian resident partners in an entity viewed by Australia as a transparent partnership but which the US perceives to be a non-transparent corporation, RCF submitted that a US court applying the Convention to that mirror transaction would be likely to see as determinative the fact that the Australian partners and not the foreign partnership derive the income in question for the purposes of the Convention.
Conclusion
For the foregoing reasons, in particular those set out at [55] to [70] above, supported as it were by RCF’s submissions at [71] to [75] above, I am of the view that while Art 13(1) of the Convention authorises Australia, by its domestic law, to tax the US resident limited partners in RCF on their respective distributive shares of the gain derived by them on the sale by RCF of the shares in SBM if its requirements are otherwise satisfied, it does not authorise Australia to tax that gain to RCF, the limited partnership, as a non-transparent company.
It follows, in my view, that there is an inconsistency between the application of the Convention and the application of the Assessment Acts as to the entity or entities to be taxed on the gain derived on the sale of the SBM shares. In accordance with the provisions of s 4(2) of the Agreements Act, that inconsistency has to be resolved in favour of the application of the Convention to the limited partners in RCF against the application of the Assessment Acts to RCF, the limited partnership.
I would therefore answer the first issue – yes: the issue of the Assessment to RCF is precluded by the Convention.
SECOND ISSUE: THE TARP ISSUE
My conclusion on the treaty issue is sufficient to allow the appeal; set aside the Commissioner’s deemed disallowance of RCF’s objection against the Assessment; and allow RCF’s objections against the Assessment and the Penalty Assessment in full. Nevertheless, out of deference to the efforts of the parties involved in preparing the TARP issue for hearing; to the proportion of the hearing time devoted to the TARP issue both in terms of evidence adduced and tested; as well as the respective submissions made in reliance on that evidence, it was agreed that even if I was to conclude as I have on the treaty issue, I should nevertheless address and determine the TARP issue. An appeal court will then have the benefit of my reasons and conclusions on both issues.
The TARP issue involves a consideration and conclusion on a number of underlying issues including:
(1)The proper construction of the “principal asset test” in s 855-30(2), in particular what is to be valued.
(2)The hypothesis upon which the valuation is to be made, and the application of that hypothesis to the case at hand.
(3)The appropriate valuation methodologies to measure what is to be valued.
The Expert Evidence
In relation to the TARP issue both parties called expert witnesses on matters of gold mining geology and valuation. RCF relied on valuation reports from Mr Mark Bryant and Mr Ken Pendergast of Ernst & Young (“EY”) (Ex 5) and from Mr Wayne Lonergan of Lonergan Edwards & Associates Ltd (“LEA”) (Ex 6), both dated 6 March 2012, while the Commissioner relied on valuation reports from Mr Robert Allison of Romar Valuation Services Pty Ltd (“Romar”) (Ex A) and from Mr Michael Potter of Axiom Forensics Pty Ltd (“Axiom”) (Ex B), both dated 4 May 2012. The Commissioner also relied on a geological report from Mr Ray Cary of Northwind Resources Pty Ltd (“Northwind”) dated 4 May 2012 (Ex F).
On 10 May 2012, the Court ordered that on or before 14 September 2012 a conference be convened among the parties’ expert valuation witnesses for the purpose of identifying matters agreed, matters not agreed and, so far as possible, narrowing or removing the differences between them (“the Conclave”). The Conclave took place on 22–24 August 2012 under the chairmanship of the Honourable Kevin Lindgren AM, QC. A Joint Report of Messrs Ken Pendergast and Mark Bryant (jointly), Wayne Lonergan, Robert Allison, Michael Potter (collectively the “Experts”) and Ray Cary dated 29 October 2012 was prepared and tendered into evidence at the hearing (Ex 7) (Experts’ Joint Report (“EJR”)). The EJR included as appendices: Supplementary Report of EY dated 26 October 2012 (Appendix III), Amended Report of LEA dated 26 October 2012 (Appendix IV), Revised calculations and sensitivities of Axiom dated October 2012 (Appendix V), Supplementary report and documents prepared by Northwind dated 6 September 2012 (Appendix VI), Northwind document dated 9 September 2012 (Appendix VII) and Romar document dated 17 October 2012 (Appendix VIII).
It is apparent, even from a review of the Executive Summary in Section A of the EJR, that there was a degree of common ground amongst the Experts, but there was also disagreement on significant issues of principle and valuation methodologies with respect to what are called SBM’s “specialised assets” – mining information, plant and equipment and mining rights. It was these areas of disagreement which led to the disparity amongst the Experts as to their conclusions on whether the sum of the market values of SBM’s TARP assets as at July 2007 and January 2008 exceeded the sum of the market values of SBM’s non-TARP assets as at those dates. Unsurprisingly, the Experts called by RCF (EY and LEA) came to the conclusion that, as at those dates, the sum of the market values of SBM’s TARP assets did not exceed the sum of the market values of SBM’s non-TARP assets while the Experts called by the Commissioner (Axiom and Romar) came to a contrary conclusion.
RCF also relied on three affidavits affirmed by Mr Eduard Eshuys, the first affirmed 1 March 2012 (Ex 3), the second affirmed 31 October 2012 (Ex 4) and the third affirmed 4 December 2012 (Ex 8). Mr Eshuys is currently Executive Chairman of Drummond Gold Limited. Between 24 July 2004 and 9 March 2009, he was Managing Director and Chief Executive Officer of SBM. He holds a Bachelor of Science majoring in Geology from the University of Tasmania. He is a fellow of the Australian Institute of Mining and Metallurgy (Aus/MM). He has over 40 years experience in the resource industry in Australia and in 1996 was awarded the Geological Society of Australia’s Joe Harms Medal for distinction in exploration success and project development. Objections were taken to [83] of Ex 3 and [11], [29] and [33] of Ex 4 where Mr Eshuys expresses opinions about the length of time necessary to recreate mining information and the costs associated therewith in respect of Sons of Gwalia ([83] of Ex 3) and in respect of Marvel Loch ([29] and [33] of Ex 4). The Commissioner submitted that to the extent Mr Eshuys asserts that certain steps would be required to “effectively recreate mining information” and the sequence of those steps at [11] of Ex 4, it is not possible to ascertain to what extent those purported opinions are in fact based on specialist knowledge or are mere speculation. He further submitted that Mr Eshuys has not set out any of his reasoning underpinning his opinions concerning the likely cost and time delay associated with recreating mining information. According to the Commissioner, Mr Eshuys has not indicated that he undertook any qualitative analysis of the information that would actually need to be replicated, nor has he set out any of the assumptions he has made for the purposes of arriving at his estimates. Therefore, even if the Court is satisfied that Mr Eshuys has relevant specialised knowledge, it is impossible to discern to what extent his opinions are based on that knowledge. Objection was also taken to [24] and [25] of Ex 4 where Mr Eshuys states that he considers confirmation drilling is necessary when recreating mining information because data in the public domain is insufficient. It was submitted that Mr Eshuys fails to set out his reasoning to support these views in a way that makes it possible to understand his reasoning, or whether his view is based on any specialised knowledge; that he has not stated what public domain information he has consulted in reaching this opinion, nor has he set out in detail exactly how it would be insufficient.
It was agreed that I should rule on these objections at the time of giving judgment and include in my reasons for judgment my reasons for so ruling. On the second day of the hearing prior to Mr Eshuys being called and cross-examined, Ex 8 was, with the leave of the Court, filed and read. It sought to deal with and answer these objections. Objection was taken to [14] of Ex 8 on the same basis as earlier objections.
Having regard to the whole of Mr Eshuys’ affidavit evidence (Exs 3, 4 and 8); his evidence in cross-examination (T84/45 to 99/7); and his evidence in re-examination (T99/19 to 102/3), I am satisfied that Mr Eshuys has requisite “specialised knowledge based on [his] … study or experience” (Ex 8 at [3] – [5], Annexure EH9) regarding the creation of mining information – how long it would take to undertake the drilling and subsequent analysis to acquire it and the costs associated therewith – and, it follows, the recreation of such information. I am also satisfied that the opinions he expresses, in particular at [83] of Ex 3, at [11], [29] and [33] of Ex 4 and [14] of Ex 8 are “wholly or substantially based on that knowledge”: s 79(1) of the Evidence Act 1995 (Cth); Dasreef Pty Ltd v Hawchar (2011) 243 CLR 588 at 602–603, [32] per French CJ, Gummow, Hayne, Crennan, Kiefel and Bell JJ.
Moreover, I do not accept that Mr Eshuys has failed to set out his reasoning as to why he considers that confirmation drilling is necessary when recreating mining information despite the availability of public information: [24] and [25] of Ex 4. Mr Eshuys sets out in considerable detail his process of reasoning including:
(1)What is meant by the term “mining information”: Ex 3 at [82];
(2)the steps involved in re-creating mining information: Ex 3 at [83]; Ex 4 at [11], [14];
(3)the nature of the costs involved in the process of creating mining information and his personal experience of the actual costs incurred by SBM in creating it: Ex 4 at [5] – [10];
(4)the categories of factors he has had regard to in arriving at his opinion: Ex 8 at [13];
(5)why public domain data is insufficient information to commence mining operations and the steps required to verify and augment it: Ex 4 at [15] – [20]; Ex 8 at [18] – [21].
Mr Eshuys’ explanations of the considerations to which he had regard and the manner in which he arrived at his opinions together with his personal experience on which they were based is consequently not “mere speculation” and is to be contrasted with that of the expert evidence rejected by the High Court in Dasreef where the witness, a chemist and chemical engineer, gave a bare estimate of the silica dust concentrations to which Mr Hawchar was exposed without any reasoning of what he based the estimate on whatsoever. RCF pointed out that while the Commissioner adduced evidence from Mr Cary, a geologist, Mr Cary pointedly does not contradict Mr Eshuys’ evidence in this regard and in particular that his estimates are overstated.
RCF submitted that submissions of the Commissioner on what is necessary for admissibility of Mr Eshuys’ opinions amounts to a “counsel of perfection”, something that the Full Court has rejected in Sydneywide Distributors Pty Ltd v Red Bull Australia Pty Ltd (2002) 55 IPR 354; [2002] FCAFC 157 at [7]. Relevance aside, all that is necessary is for the Court to be satisfied, on the balance of probabilities, that the opinion is based wholly or substantially on that knowledge: ibid at [14]. According to RCF, it cannot be seriously suggested that Mr Eshuys’ opinion is not wholly or substantially based on his specialised knowledge.
So much may be accepted. In any event, an expert with considerable experience accumulated over the course of a long career can generalise, based on their experience, their opinion without having to prove all the facts upon which their evidence is based: Arnotts Ltd v TPC (1990) 24 FCR 313 at 350–351; Pan Pharmaceuticals Ltd (in Liq) v Selim [2008] FCA 416 at [25]–[26] per Emmett J.
For these reasons, I reject the objections to Mr Eshuys’ affidavit evidence raised by the Commissioner.
Statutory Context
Division 855 of Part 4-5 was inserted in the 1997 Act by Act No 168 of 2006. Section 855-1 relevantly provides that a foreign resident can disregard a capital gain or loss unless the relevant CGT asset is a direct or indirect interest in Australian real property.
Section 855-10 directs that a capital gain from a CGT event is to be disregarded if “you are” a foreign resident and the event happens in relation to a CGT asset that is not taxable Australian property.
The shares disposed of by RCF will be taxable Australian property if they are an “indirect Australian real property interest” (item 2 of the table in s 855-15), a status which relevantly depends on whether they are an interest which passed the principal asset test set out in s 855-30. Section 855-30 relevantly provides:
(1) The purpose of this section is to define when an entity’s underlying value is principally derived from Australian real property (see paragraph 855-5(2)(b)).
(2) A *membership interest held by an entity (the holding entity) in another entity (the test entity) passes the principal asset test if the sum of the *market values of the test entity’s assets that are taxable Australian real property exceeds the sum of the *market values of its assets that are not taxable Australian real property.
Sub-section (1) speaks of the purpose of the section as being to define when an entity’s underlying value is principally derived from Australian real property. What the section is concerned to measure is not the value (singular) of SBM or all the assets of its business as a going concern, but the values (plural) of its underlying assets (whether or not used in a business) and to define when the sum of the values of its underlying assets (what it calls the “entity’s underlying value”) is principally derived from Australian real property. Sub-section (2) provides the criterion for passing the “principal asset test”: when the sum of the market values of the entity’s assets that are TARP exceeds the sum of the market values of its assets that are non-TARP.
It is clear from the text of s 855-30(2) that the “principal asset test” requires the separate determination of the market value of each of the entity’s assets; not the determination of the market value of all its TARP assets as a class and the determination of the market value of all its non-TARP assets as a class (although where an entity has only two or three assets in a particular class, such a determination may be tempting as a surrogate short-cut); and certainly not the determination of the market value of all its assets on a going concern basis. The test further requires the classification of these assets into TARP or non-TARP. Finally, it requires the summing of the values in each class to determine whether the sum of the market values of the entity’s TARP assets exceed the sum of the market values of the entity’s non-TARP assets; only if it does, is the “principal asset test” passed.
It is trite that the value of a business on a going concern basis valued by reference to the present value of predicted earnings of the business may be greater than the sum or aggregate of the individual market value of each identifiable asset comprising the business: Federal Commissioner of Taxation v Murry (1998) 193 CLR 605 at [49]; Commissioner of Territory Revenue v Alcan (NT) Alumina Pty Ltd (2008) 156 NTR 1 at [116] per Angel J. Whether or not it is correct to characterise the difference as goodwill in the legal sense, an issue on which the Northern Territory Court of Appeal was split in the latter case, may or may not be relevant in the present case. It will depend on the figures. In the present case, if the difference is goodwill in the legal sense, and therefore property of SBM, it is, on any view, a non-TARP asset. If it is not goodwill in the legal sense and therefore not property of SBM, it will be neither a TARP asset nor a non-TARP asset. However, importantly for present purposes, if a going concern valuation of all of SBM’s assets is used for allocating market values to individual assets of SBM as a surrogate for undertaking separate valuations of those assets on a stand-alone basis, an overstatement of those values will result and, depending on the basis of allocation, an overstatement of the market values and therefore the sum of those values of the TARP assets or an overstatement of the market values and therefore the sum of those values of the non-TARP assets; or both. To use a term used by Angel J in Alcan (NT) at [116], it “jumbles” the value of goodwill, or the marriage value of the assets, with its sources.
The Valuation Hypotheses
One area of controversy or dispute between the parties on the TARP issue concerns the hypotheses by reference to which a value is to be measured. The use of the words “market value” (as compared, for example, to “value in use”) imports the notion of the value that could be realised on exchange. All the Experts adopted (EJR at [10], [37]) a formulation derived from Spencer v The Commonwealth (1907) 5 CLR 418 at 432 (Griffiths CJ), 441 (Isaacs J):
The value that would be agreed, in an open and unrestricted market, between a knowledgeable, willing but not anxious buyer and a knowledgeable, willing but not anxious seller acting at arm’s length.
This formulation does not involve an inquiry into the price a person desiring to sell could actually have obtained for it on a given day, but is predicated on a hypothetical sale within the terms of the formulation. So much is clear from what Griffith CJ said in Spencer at 432:
It may be that the land is fit for many purposes, and will in all probability be soon required for some of them, but there may be no one actually willing at the moment to buy it at any price. Still it does not follow that the land has no value. In my judgment the test of value of land is to be determined, not by inquiring what price a man desiring to sell could actually have obtained for it on a given day, i.e., whether there was in fact on that day a willing buyer, but by inquiring “What would a man desiring to buy the land have had to pay for it on that day to a vendor willing to sell it for a fair price but not desirous to sell?”
In Spencer, Isaacs J at 440–441 described “the fair price of the land” as being, that “which a hypothetical prudent purchaser would entertain, if he desired to purchase it for the most advantageous purpose for which it was adapted”. This has been referred to as the “highest and best use” of the asset to be valued: Boland v Yates Property Corporation Pty Ltd (2007) 167 ALR 575 at [271]–[274] per Callinan J. There was consensus among the Experts that the highest and best use of SBM’s “specialised assets” is in a business of mining the reserves in SBM’s mining tenements.
RCF submitted that having regard to the text of s 855-30 and what it requires to be determined, the formulation to be derived from Spencer and the many cases in which it has been followed is to ask of the asset to be valued: What, if that asset only were to be offered for sale, would be agreed as its price between knowledgeable, willing but not anxious parties acting at arm’s length? In other words, the asset is to be valued by reference to the hypothetical price that would be agreed between such parties on a stand-alone basis as if no other asset were offered for sale. On the other hand, the Commissioner submitted that the formulation to be derived from Spencer and Yates Property Corporation, in particular the price that a hypothetical purchaser would pay for the most advantageous purpose for which the asset is adapted, or its “highest and best use”, required a valuation of the assets of SBM on the basis of a hypothetical sale of all of those assets on a going concern basis and the allocation of that “total combined asset market value to the categories of TARP assets and Non-TARP assets” (Memorandum of Axiom to Maddocks of 29 November 2012 (Ex D)).
Both submissions are not without their problems. Fundamentally, RCF’s formulation is, in my view, the correct starting point. However, the formulation needs to go further and incorporate the further assumption that, in the case of hypothetical transactions involving mining information or plant and equipment, the hypothetical purchaser is the owner of the mining rights and, as such, is able to use the relevant asset, mining information or plant and equipment, in a manner consistent with the most advantageous purpose for which it is adopted or, its “highest and best use”. All the Experts agreed that this was in a business of mining the reserves in SBM’s mining tenements.
Fundamentally, the Commissioner’s submission, which mirrored the approach of those of the Experts he called, in particular Axiom, is wrong. It is contrary to the statutory criterion mandated by s 855-30(2) as outlined in [95] to [97] above. As previously noted, s 855-30(2) is not concerned with the determination of the market value of all of SBM’s assets as a going concern; it is concerned with the determination of the individual market values of SBM’s assets, at least before the summing and comparison of the dual classification of those assets.
The Commissioner contended that bizarre results would flow from a formulation of the hypothesis to be derived from Spencer that postulated that no asset, other than the asset to be valued, was to be offered for sale. For example, in the case of mining information, such a hypothesis, it was submitted, would be destructive of its value and, in the case of other assets, for example, plant and equipment, it would inevitably result in it having little, or no, value depending on whether the transport costs to move it off site exceeded its tolling or second-hand value. But that would not be the case if the formulation incorporates the further assumption referred to in [102] above.
The Valuation Methodologies
Adoption of such hypotheses would require different methodologies in relation to different assets. In the case of the mining rights, their hypothetical price, as the determinant of their individual market value, would be the value which could be extracted from the tenements by mining them, as ascertained by reference to discounted cashflows, less the cost (time delay cost as well as outlay) of re-creating the mining information and replacing the plant and equipment assumed not to be owned by the owner of the mining rights and not otherwise available for purchase. Such a methodology is consistent with that adopted by the Supreme Court of Western Australia in Nischu Pty Ltd v Commissioner of State Taxation (WA) (1990) 21 ATR 329 and by the Full Court of that Court on appeal: Commissioner of State Taxation (WA) v Nischu Pty Ltd (1991) 4 WAR 437 in relation to the valuation of the land of Murchison Zinc Company Pty Ltd (“Murchison”); recognising that “in agreeing upon a price for the land, the hypothetical vendor and purchaser would have regard to the cost of regenerating or acquiring the important information that would not otherwise be available to the purchaser after the sale” (at 396). A fortiori in the case of the plant. The Full Court unanimously dismissed the Commissioner’s appeal from this decision and held that the mining tenements were correctly valued on the basis that “the hypothetical vendor and purchaser would have regard to the cost of regenerating or acquiring the important information that would not otherwise be available to the purchaser after the sale. This cost would cause the parties to reduce the price that would otherwise be appropriate for Murchison’s land” (at 445 per Malcolm CJ; at 456 per Wallace and Pidgeon JJ each concurring), and that the cost had properly been assessed by taking into account “the cost of replacing the information, costs or losses resulting from consequential delay in development … and the risk of unforeseen costs” using a discounted cash flow analysis (at 448 per Malcolm CJ).
LEA approached the task of calculating the maximum value of TARP assets in a similar way: the value of all assets of SBM (assessed on a DCF basis plus the value of assets not included in the DCF analysis) less the value of non-TARP assets. LEA’s revised DCF valuation took into account the expert geological evidence of Mr Cary and his analysis of the confidential SBM information obtained on subpoena. This caused LEA to reduce its assessment of the volume of gold able to be produced and hence reduced its DCF valuation as follows (at CB2510 [17]):
SBM – net present value of mining operations(1) Jul 2007
$MJan 2008
$MDCF – Southern Cross
91
248
DCF – Gwalia 308 600 Corporate overheads (61) (53) Net present value of mining operations
338
795
Note:
1 Based on the SBM DCF model of which a version, corrected for errors, has been agreed by the Experts.
In its earlier report, in calculating total assets of SBM, LEA did not allow for the rehabilitation liabilities that would be incurred by SBM at the end of the mining operations. Based on the disclosures in the SBM financial statements, LEA estimated these to be some $19 million (in present value terms) at July 2007, and some $20 million (in present value terms) at January 2008. Incorporating these and other amendments, LEA reviewed its calculation of total assets of SBM to the following (at CB2515 [40]):
SBM total assets Para Jul 2007
$MJan 2008
$MValue as per DCF analyses
17
338
795
Less: Rehabilitation provision not allowed for in the DCF
18
(19)
(20)
Add: Items not reflected in DCF analysis
Cash 96 115 Derivatives 13 20 Available for sale financial investments 22 20 19 Tax losses 19 24 Value of resources outside of mine plans and extensions 21 34 59 Exploration tenements 20 23 23 Cash receivable from option exercise 39 5 6 SBM – total assets
528
1,041
LEA valued non-TARP assets other than plant and mining information at their realisable value to SBM (which, according to the type of asset, may be face value or traded price). Plant was valued at depreciated replacement cost and mining information was valued at its replacement cost plus – the plus being the taking into account cash outlays and the loss of cash flow until the re-creation process was complete.
Mining Information
In its earlier report, LEA adopted the assumption that the mining information for the mining operations at both Southern Cross (principally Marvel Loch) and Leonora (Gwalia Deeps) would both take four years to reproduce. As a result of reviewing the material in Mr Eshuys’ second affidavit (Ex 4), LEA in its amended valuation adopted a two year period for re-creation of mining information at Marvel Loch and the Southern Cross satellite operations (at CB2512 [29]). This resulted in the following amended values being attributed to mining information (at CB2514 [36]):
Value attributable to mining information Jul 2007
$MJan 2008
$MCash cost – Gwalia
42(1)
42
Cash cost- Southern Cross resources and Leonora other resources 29 39 Total cash costs 72 81 Time value component 106 275 SBM – value attributable to mining information
178
356
Note:
1 Refer paragraphs 8 and 10 of Mr Eshuys’ Second Affidavit.
Plant and Equipment
In its earlier report, LEA assessed the value of plant and equipment to the information set out in Mr Eshuys’ first affidavit (Ex 3) and with reference to the price paid for plant, equipment and infrastructure at other gold mines including that of Avoca Resources in June 2008. LEA conceded that in including reference to Avoca Resources Plant and Equipment acquisition, it did not make appropriate allowance for the “non-linear” relationship between plant and equipment capacity and costs. LEA’s revised value for plant and equipment are principally derived with reference to the estimate advanced by Mr Eshuys (CB2511 [23]) and [24]). This is set out in the table below (CB2512 [25]):
Plant and equipment Jul 2007
$MJan 2008
$MSouthern Cross(1)
50
50
Leonora(1) 60 60 Less: spend to be incurred July to January on plant at Leonora (8) - Tarmoola (sale value) 3 3 Accommodation(2) 8 9 Mobile equipment(2) 4 13 117
135(2)
Note:
1 Per Eshuys, excludes generator cost as Southern Cross was on the electricity grid.
2 My total value is consistent with Romar’s high end total value in January 2008.
Maximum Value of TARP Assets
Based on the discussions held with the other Experts in this matter and the information in Mr Eshuys second affidavit (Ex 4) LEA amended its valuation opinions of the TARP and non-TARP assets held by SBM as at July 2007 and January 2008 to the following (CB2509 [12]):
SBM – value of TARP assets Jul 2007
$MJan 2008
$MValue of SBM’s interest in all assets
528
1,041
Value of SBM’s interest in non-TARP assets: Cash 96 115 Working capital 16 23 Derivatives 13 20 Available for sale financial investments 20 19 Plant and equipment 117 135 Mining information 178 356 Goodwill 10 20 Tax losses 18 24 Cash receivable from options exercise 5 6 Total non-TARP assets
472
718
Value of total TARP assets 56 323 Value of TARP as a percentage of total assets
10.6%
31.1%
Axiom’s Methodology
Approach
Axiom approached the task of valuation on the basis that s 855-30(2) of the 1997 Act required the assets of SBM to be valued on a going concern basis and then to allocate “the total combined assets market value to the categories of TARP assets and Non-TARP assets”. It adopted this approach as a necessary reflection of the “highest and best use” principle embedded in the hypothesis to be derived from Spencer. Its approach is exemplified in the summary below extracted from Ex D:
The ITAA requires an assessment of the market value of the assets of SBM in a hypothetical sale(s), not the market value for ownership interests in SBM.
The definition of market value provided in Spencer’s case applies i.e. the value that would be agreed, in an open and unrestricted market, between a knowledgeable, willing but not anxious buyer and a knowledgeable, willing but not anxious seller acting at arm’s length.
The assets associated with the mining interests of SBM have been valued on the basis they are hypothetically sold in their combined form, principally the Gwalia and Southern Cross mining interests, in a simultaneous transaction, by hypothetical vendor(s) to hypothetical purchaser(s). This assumption is made on the basis that the best sale price will be achieved if the sale is on a going concern basis as it is the “highest and best use” (this will include “marriage value”).
…
It is then necessary to allocate the total combined assets market value to the categories of TARP assets and Non-TARP assets sold in combination for Gwalia and Southern Cross to arrive at individual asset market values. The TARP asset categories primarily comprise mining rights and land improvements (where the land improvements can be considered as separate TARP assets or are included in mining rights on the basis the owner of the mining rights has use of such improvements which would improve its value). The Non-TARP asset categories primarily comprise mining information and plant & equipment.
The appropriate method of allocation is the residual approach: The value of the TARP assets included in the Gwalia and Southern Cross mining interests is the difference between the total combined asset market value and the Non-TARP assets market value.
(Emphasis added.)
As indicated at [101] to [104] above, I do not think that the “highest and best use” principle embedded in the hypothesis to be derived from Spencer supports an approach which would construe s 855-30(2) as requiring the valuation of something the text of the section is not concerned with.
Mining Information
In the tables at [123] above, Axiom has valued SBM’s mining information on two different bases. The first (Axiom 1) on a book value basis which, as at 26 July 2007, is put at $18 million; and as at 29 January 2008 at $20 million. Under the second (Axiom 2) mining information is valued on a replacement value basis (excluding time delay costs) at $55 million as at 26 July 2007 and $68 million as at 29 January 2008. However, these latter figures are figures which Axiom was instructed to adopt rather than figures that Axiom independently calculated. So much is explained in Axiom’s report of 4 May 2012 at [14.115] (Ex B, CB1076):
Whilst I note that it is possible to calculate the replacement cost of each of SBM’s assets, undertaking such an exercise is outside my expertise.
Plant and Equipment
In the tables at [123] above, Axiom valued SBM’s plant and equipment at book value under both Axiom 1 and Axiom 2 – $14 million as at 26 July 2007 and $31 million as at 29 January 2008.
Following the Conclave, Axiom calculated a value for plant and equipment on a replacement cost basis which it described as follows (EJR, Appendix V, CB2535):
2.13… The replacement cost that I calculate, which excludes delay costs, is a ‘DORC’ value which I base on the integers adopted by Mr Lonergan, corrected for what I consider to be:
2.13.1Mathematical errors in the calculation; and
2.13.2The inclusion of the requirement that the plant is optimised.
2.14For detailed calculations of my replacement cost of property, plant and equipment values refer to Microsoft Excel document “Axiom updated DCF valuation model from Conclave amendments” (‘Potter PPE (DORC)’ tab).
2.15The replacement cost value of property, plant and equipment I have calculated is:
2.15.1$51 million as at 26 July 2007; and
2.15.2$67 million as at 29 January 2008.
In consequence, Axiom revised its calculations of TARP assets and non-TARP assets from those appearing in the tables at [123] above, as follows (EJR, Appendix V, CB2535 [2.16]):
Table 18: TARP assets and non-TARP assets ($’m)
26 July 2007
Base valuation
Sensitivity valuation
Variance
TARP assets
Non-TARP assets329
178253
249(76)
71TARP less non-TARP assets
TARP as % of total assets151
64.9%4
50.4%(147)
(14.5%)29 January 2008
Base valuation
Sensitivity valuation
Variance
TARP assets
Non-TARP assets719
226634
308(86)
82TARP less non-TARP assets
TARP as % of total assets493
76.0%325
67.3%(168)
(8.8%)
By way of analysis of Axiom’s methodology, in addition to the fundamental observation at [146] above, I would, at this stage, proffer two further observations. First, it is difficult to attach any weight to Axiom’s revised calculations in [149] above in the face of the extract from its original report reproduced in [147] above. Second, and this goes to the fundamental basis upon which Axiom allocates the total market value of SBM’s assets, or at least its “specialised assets”, to arrive at individual market values of TARP assets and non-TARP assets, namely, book value, Axiom itself concedes (Ex B, CB1076):
14.116… There are some problems with the application of book value. For example, it is well understood that book value of an asset such as plant and equipment is rarely an accurate measure of its market value.
(Emphasis added.)
Consideration and Analysis of the TARP Issue
Before undertaking an analysis of the interaction between the statutory criterion of s 855-30(2), in other words, what it calls to be valued, my formulation of the hypotheses upon which the measurement of that value is to be determined (see [102] and [104] above) and the methodologies to be employed in the measurement process (see [105] to [107] above), I should say I do not propose to rely on Romar’s figures or calculations for the reasons explained at [116] to [122] above. This is consistent with the final submissions made on behalf of the Commissioner on the last day of the hearing; his senior counsel relied exclusively on the hypothesis, methodology and calculations of Axiom in support of his defence of the Assessment, and his ultimate contention that the sum of the market values of SBM’s TARP assets exceeded the sum of the market value of its non-TARP assets at both 26 July 2007 and 29 January 2008.
Nor, albeit for different reasons, do I propose to rely on Axiom’s figures or calculations. First and foremost, its fundamental approach that s 855-30(2) of the 1997 Act required the assets of SBM to be valued on a going concern basis and then to “allocate the total combined asset market value to the categories of TARP assets and Non-TARP assets” (Ex D) finds no support in the statute. With respect, it is wrong. Second, its reliance on book values as the market values of the mining information and plant and equipment, is, by Axiom’s own concession “rarely an accurate measure” (see [151] above). Third, Axiom’s Axiom 2 calculations of the replacement cost of plant and equipment as at 26 July 2007 and 29 January 2008 are “outside [its] expertise” (see [147] above). Finally, its rejection of the methodology approved and adopted in Nischu in valuing Murchison’s mining property in reliance on factual distinctions between that case and the present case, is not persuasive. They seem to me to be distinctions without a difference.
Mining Rights
For the purpose of valuing SBM’s principal mining rights on the hypothesis that they are th e only asset offered for sale, the starting point, as indicated in [105] above, is the revised DCF derived values of SBM’s mining operations at the relevant dates as disclosed in the table in [124] above:
EY LEA $M $M 25 July 2007
247
319
29 January 2008
700
775
The next step in the methodology, as explained in [105] above, is to deduct the cost, time delay as well as outlay, of re-creating the mining information and replacing the plant and equipment, those assets not being offered for sale under the hypothesis, to arrive at the value of the principal mining rights. This is depicted in the table below for each of EY and LEA at the relevant dates:
EY
LEA
EY
LEA
July
$M
July
$M
January
$M
January
$M
DCF of mining operations
247
319
700
775
LESS:
Cost of re-creating mining information 164(1) 178(2) 257(1) 356(2) Cost of replacing plant 66(3) 117(4) 95(3) 135(4) Time delay(5) 19 23 54 62 (2)
1
294
222
TARP Value Value of mining rights (2) 1 294 222 ADD:
Land in Subsidiary 1 – 1 – Other exploration areas 23 57 23 82 Total Market Value of TARP Assets
22(6)
58(7)
318(6)
304(7)
Notes:
1 Includes time delay costs: see [133] above.
2 Includes time delay costs: see [142] above.
3 See [134] and [135] above, excludes time delay costs.
4 See [143] above; excludes time delay costs.
5 Ex 10 time delay recorded for LEA and these figures are replicated for EY.
6 Figures vary from those at [135] above due to time delay costs for replacement of plant and equipment.
7 Figures vary from those at [144] above: $56 million at July and $323 million at January.
Mining Information
For the purpose of valuing SBM’s mining information on the hypothesis that it is the only asset offered for sale and on the further assumption referred to in [102] above, the hypothetical price of the mining information, as the determinant of its market value, would be negotiated in a range somewhere between a low point, being the amount to be realised by the hypothetical vendor if no transaction is done (zero), or an equivalent nominal amount on its sale to a purchaser not being the owner of the mining rights, and a high point, being the cost, time delay as well as outlay, to the hypothetical purchaser of re-creating the mining information.
While there is an upper and lower point to the hypothetical negotiation range, there is no logical intermediate point guided by any business or financial principle. It follows, that if the task were to predict the outcome of such an actual negotiation, as a question of fact, the Court has no assistance and no evidentiary basis for doing so. But that is not the task here: the task under s 855-30(2) is to ascertain a market value, and the hypothetical sale transaction is no more than a useful and conventional method for doing so. I agree with RCF’s submission that an appropriate basis for ascertaining market value in such a case is one which fairly arrives at a value, and that the fair valuation is one which shares equally between the holder, and the potential user, of the relevant asset the benefit to the user of immediate acquisition of the asset. That value is ascertained by dividing the notional “bargaining zone” equally. In this way, the hypothetical price of the mining information, as the determinant of its market value, is arrived at as a mid point between the maximum that the hypothetical purchaser, as the owner of the mining tenements, might pay to acquire the information (being the amount of outlay and the value of loss of cashflow suffered to re-create it) and the maximum the hypothetical vendor of the information could realise from any other disposal of the information. This is depicted in the table below for each of EY and LEA at the relevant dates:
EY LEA EY LEA July
$MJuly
$MJanuary
$MJanuary
$MCost to re-create mining information including time delay costs (A)(1) 164
178
257
356
Mid-point between 0 and figure (A)
82
89
129
178
Note:
1 See [155] above
Mining Plant and Equipment
For the purposes of valuing SBM’s plant and equipment on the hypothesis that it is the only asset offered for sale and on the further assumption referred to in [102] above, the hypothetical price of the plant and equipment, as the determinant of its market value, would be negotiated in a range somewhere between a high point, being the cost (including the time delay cost) to the hypothetical purchaser of acquiring replacement plant and equipment and a low point, being the price that could be expected for the plant and equipment on its resale elsewhere, that is, other than to the owner of the mining rights.
Again, there is no logical intermediate point guided by any business or financial principle. But again, this is not an impediment to the task of ascertaining a market value by reference to a hypothetical price on a hypothetical transaction. Again, I agree with one which fairly arrives at a value, and that the fair valuation is one which shares equally between the holder, and the potential user, of the relevant asset the benefit to the user of immediate acquisition of the asset. That value is ascertained by dividing the notional “bargaining zone” equally. In this way, the hypothetical price of the plant and equipment, as the determinant of its market value, is arrived at as a mid point between the maximum that the hypothetical purchaser, as the owner of the mining tenements, might pay to acquire replacement plant and equipment (being the amount of outlay and the value of loss of cashflow suffered to replace it) and the maximum the hypothetical vendor of the plant and equipment could realise from any other disposal of it. This is depicted in the table below for each of EY and LEA at the relevant dates:
EY LEA EY LEA July
$MJuly
$MJanuary
$MJanuary
$MCost to replace plant including time delay cost(A)(1) 85
140
149
197
Value of plant for sale and removal (B) 18(2) 18(3) 32(2) 32(3) Mid-point range between (A) and (B) 52 79 91 115 Note:
1 See [155] above
2 See [123] above
3 Replicated from EY figures at [123] above
The remaining goodwill or “marriage value” of the assets would be the residual value calculated as follows:
EY LEA EY LEA July
$MJuly
$MJanuary
$MJanuary
$MDCF value of mining operation(1)
247
319
700
775
Less: Mining rights(2) 2 (1) (294) (222) Information (3) (82) (89) (129) (178) Plant(4) (52) (79) (91) (115) Working capital(5) (17) (16) (22) (23) Intangible
98
134
164
237
Note:
1 See [124]; [154] above
2 See [155] above
3 See [157] above
4 See [159] above
5 See [123] above
Whether the Principal Asset Test is passed by SBM
Set out at [163] and [164] below in tabular form are sets of calculations based on the foregoing analysis of the individual market values of SBM’s assets, in particular, its “specialised assets” – mining rights, mining information and plant equipment. The market values of its other assets were largely uncontroversial and any diversity of opinion amongst the Experts was, at worst, only marginal. Again, this is reflected in the tables below, albeit confined as they are to EY and LEA.
The first table of calculations is predicated on the basis that the residual intangible figures as calculated in [160] above, represent goodwill in the legal sense referred to by the majority in Alcan (NT) and therefore is property of SBM. However, as indicated at [97] above, on no view would that be a TARP asset.
The second table of calculations is predicated on the basis that the residual intangible figures as calculated in [160] above, do not represent goodwill in the legal sense referred to and therefore is not property of SBM. On that view, it is treated as neither a TARP asset nor a non-TARP asset of SBM at the relevant dates.
The first table of calculations leads to the following results:
TABLE 1
July 2007 January 2008 EY
$MLEA
$MEY
$MLEA
$MTARP assets(1)
Mining rights (2) 1 294 222 Value of resources outside mine plans 34(2) 59(2) Exploration tenements 23 23(2) 23 23(2) Other 1 1 22
58
318
304
Non-TARP assets Cash(3) 95 96 115 115 Working capital(3) 17 16 22 23 Derivatives(3) 13 13 20 20 Available for sale financial assets (non-TARP)(3) 19 20 19 19 Tax losses(3) 19 18 24 24 Mining information(4) 82 89 129 178 Plant(5) 52 79 91 115 Goodwill(6) 98 134 164 237 395
465
584
731
TARP 22 58 318 304 Non-TARP 395 465 584 731 Notes:
1 See [155] above
2 These figures are grouped together as “other exploration areas” in [155] above
3 See July table and January table at [123] above
4 See [157] above
5 See [159] above
6 See [160] above
The second table of calculations leads to the following results:
TABLE 2
July 2007 January 2008 EY
$MLEA
$MEY
$MLEA
$MTARP assets(1)
Mining rights (2) 1 294 222 Value of resources outside mine plans 34(2) 59(2) Exploration tenements 23 23(2) 23 23(2) Other 1 1 22
58
318
304
Non-TARP assets Cash(3) 95 96 115 115 Working capital(3) 17 16 22 23 Derivatives(3) 13 13 20 20 Available for sale financial assets (non-TARP) (3) 19 20 19 19 Tax losses(3) 19 18 24 24 Mining information(4) 82 89 129 178 Plant(5) 52 79 91 115 Goodwill 297
331
420
494
TARP 22 58 318 304 Non-TARP 297 331 420 494 Notes:
1 See [155] above
2 These figures are grouped together as “other exploration areas” in [155] above
3 See July table and January table at [123] above
4 See [157] above
5 See [159] above
On these results, SBM does not pass the principal asset test in s 855-30 of the 1997 Act at either of the relevant dates.
For the foregoing reasons, RCF’s appeal must be allowed with costs.
I certify that the preceding one hundred and sixty-seven (167) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Edmonds. Associate:
Dated: 26 April 2013
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