Spassked Pty Ltd v Commissioner of Taxation (No 5)
[2003] FCA 84
•14 FEBRUARY 2003 CORRIGENDUM 15 SEPTEMBER 2003
FEDERAL COURT OF AUSTRALIA
Spassked Pty Ltd v Commissioner of Taxation (No 5) [2003] FCA 84
CORRIGENDUM
SPASSKED PTY LIMITED (ACN 003 255 847) v COMMISSIONER OF TAXATION – N 1362 OF 1999
STANLEY PARK LIMITED (ACN 008 432 997) v COMMISSIONER OF TAXATION – N 1363 OF 1999
INDUSTRIAL EQUITY LIMITED (ACN 004 617 164) v COMMISSIONER OF TAXATION – N 1364 OF 1999
LINDGREN J
14 FEBRUARY 2003
(CORRIGENDUM 15 SEPTEMBER 2003)
SYDNEY
IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY
N 1362 OF 1999
BETWEEN:
SPASSKED PTY LIMITED (ACN 003 255 847)
APPLICANTAND:
COMMISSIONER OF TAXATION
RESPONDENT
IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY
N 1363 OF 1999
BETWEEN:
STANLEY PARK LIMITED (ACN 008 432 997)
APPLICANTAND:
COMMISSIONER OF TAXATION
RESPONDENT
IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY
N 1364 OF 1999
BETWEEN:
INDUSTRIAL EQUITY LIMITED (ACN 004 617 164)
APPLICANTAND:
COMMISSIONER OF TAXATION
RESPONDENT
JUDGE:
LINDGREN J
DATE:
14 FEBRUARY 2003
CORRIGENDUM 15 SEPTEMBER 2003PLACE:
SYDNEY
CORRIGENDUM
In [192], in the second passage within square brackets in the quoted passage, delete “primary” and substitute “dissenting”, so that it reads “[the dissenting Judge]” rather than “[the primary Judge]”.
I certify that the preceding numbered paragraph is a true copy of the Corrigendum to the Reasons for Judgment herein of the Honourable Justice Lindgren. Associate:
Dated: 15 September 2003
FEDERAL COURT OF AUSTRALIA
Spassked Pty Ltd v Commissioner of Taxation (No 5) [2003] FCA 84
INCOME TAX – deduction – interest on loan – group of numerous companies – shares of ultimate holding company (IEL) listed on Australian Stock Exchange – intermediate holding company (Spassked) borrowed funds from finance company (IEF) within the group – Spassked, a large “dividend trap” and loss making company – Spassked incurred interest on borrowed funds – used borrowed funds to subscribe for shares in subsidiary (GIH) – GIH established with two classes of shares, “A” and “B” – “A” class, carrying right to franked and unfranked dividends, held by Spassked – “B” class, carrying right to franked dividends only, held by IEL – GIH invested profitably in various subsidiary companies – Spassked incurred tax losses as a result of interest expenses – Spassked transferred tax losses pursuant to s 80G of the Income Tax Assessment Act 1936 (Cth) to other members of the corporate group – whether interest an allowable deduction under s 51(1) of the Income Tax Assessment Act 1936 (Cth) – whether, in consequence, losses had been available to be transferred – whether Spassked had expectation of gaining or producing assessable income – whether subjective purpose in incurring expense relevant to determining deductibility under s 51(1) of the Income Tax Assessment Act 1936 (Cth) – significance of “expectations” – whether expectation of receipt of dividends occasioned the borrowing of money from IEF at interest
INCOME TAX – Commissioner’s contention that application incompetent as no amount of tax payable in the relevant year of income and therefore no “assessment” within the meaning of s 175A of the Income Tax Assessment Act 1936 (Cth) – whether determination that no amount of tax payable is not an “assessment” within the meaning of s 175A of the Income Tax Assessment Act 1936 (Cth) and, therefore, not an “appealable objection decision” with which the taxpayer is “dissatisfied” within the meaning of s 14ZZ of the Taxation Administration Act 1953 (Cth)
Taxation Administration Act 1953 (Cth) ss 14ZL, 14ZQ, 14ZY, 14ZZ, 14ZZN, 14ZZO
Income Tax Assessment Act 1936 (Cth) ss 51(1), 175AAmmonia Soda Co Ltd v Chamberlain [1918] 1 Ch 266 cited
Marra Developments Ltd v BW Rofe Pty Ltd [1977] 2 NSWLR 616 cited
Batagol v Federal Commissioner of Taxation (1963) 109 CLR 243 distinguished
Stuart (No 2) v Federal Commissioner of Taxation (1996) 96 ATC 4942 distinguished
Deputy Federal Commissioner of Taxation v Sheehan (1986) 86 ATC 4718 distinguished
Federal Commissioner of Taxation v Ryan (2000) 201 CLR 109 distinguished
Steele v Deputy Commissioner of Taxation (1999) 197 CLR 459 cited
Hart v Federal Commission of Taxation (2002) 2002 ATC 4608 followedAmalgamated Zinc (De Bavay’s) Ltd v Federal Commissioner of Taxation (1935) 54 CLR 295 cited
Commissioner of Taxation (Cth) v Riverside Road Lodge Pty Ltd (in liq) (1990) 23 FCR 305 cited
Ronpibon Tin NL & Tongkah Compund NL v Federal Commissioner of Taxation (1949) 78 CLR 47 discussed
AGC (Advances) Ltd v Federal Commissioner of Taxation (1975) 132 CLR 175 cited
Fletcher v Federal Commissioner of Taxation (1991) 173 CLR 1 followed
Commissioner of Taxation v Consolidated Press Holdings Ltd (2001) 207 CLR 235 cited
Lunney v Commissioner of Taxation (1958) 100 CLR 478 cited
Federal Commissioner of Taxation v Snowden & Wilson Pty Ltd (1958) 99 CLR 431 cited
Brookton Co-operative Society Ltd v Commissioner of Taxation (1981) 147 CLR 441 distinguished
Federal Commissioner of Taxation v Total Holdings (Australia) Pty Ltd (1979) 43 FLR 217 discussed
Federal Commissioner of Taxation v EA Marr and Sons (Sales) Ltd (1984) 84 ATC 4580 distinguished
Ure v Federal Commissioner of Taxation (1981) 50 FLR 219 cited
Service v Commissioner of Taxation (2000) 97 FCR 265 discussed
Magna Alloys and Research Pty Ltd v Federal Commissioner of Taxation (1980) 49 FLR 183 followed
John v Federal Commissioner of Taxation (1989) 166 CLR 417 cited
Commissioner of Taxation v Spotless Services Ltd (1996) 186 CLR 404 cited
Pascoe v Commissioner of Taxation (1956) 30 ALJ 402 citedSPASSKED PTY LIMITED (ACN 003 255 847) v COMMISSIONER OF TAXATION – N 1362 OF 1999
STANLEY PARK LIMITED (ACN 008 432 997) v COMMISSIONER OF TAXATION – N 1363 OF 1999
INDUSTRIAL EQUITY LIMITED (ACN 004 617 164) v COMMISSIONER OF TAXATION – N 1364 OF 1999
LINDGREN J
14 FEBRUARY 2003
SYDNEY
IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY
N 1362 OF 1999
BETWEEN:
SPASSKED PTY LIMITED (ACN 003 255 847)
APPLICANTAND:
COMMISSIONER OF TAXATION
RESPONDENT
JUDGE:
LINDGREN J
DATE OF ORDER:
14 FEBRUARY 2003
WHERE MADE:
SYDNEY
THE COURT ORDERS THAT:
1.The respondent’s motion, brought by notice of motion filed on 1 December 2000, be dismissed.
2.The proceeding be stood over to 11 March 2003 for the making of orders, including orders as to costs.
3.The parties supply to the Associate to Lindgren J by 7 March 2003 an agreed form of orders or, failing agreement, the forms of orders for which they respectively contend and written submissions in support of those orders.
Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.
IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY
N 1363 OF 1999
BETWEEN:
STANLEY PARK LIMITED (ACN 008 432 997)
APPLICANTAND:
COMMISSIONER OF TAXATION
RESPONDENT
JUDGE:
LINDGREN J
DATE OF ORDER:
14 FEBRUARY 2003
WHERE MADE:
SYDNEY
THE COURT ORDERS THAT:
1.The proceeding be stood over to 11 March 2003 for the making of orders, including orders as to costs.
2.The parties supply to the Associate to Lindgren J by 7 March 2003 an agreed form of orders or, failing agreement, the forms of orders for which they respectively contend and written submissions in support of those orders.
Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.
IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY
N 1364 OF 1999
BETWEEN:
INDUSTRIAL EQUITY LIMITED (ACN 004 617 164)
APPLICANTAND:
COMMISSIONER OF TAXATION
RESPONDENT
JUDGE:
LINDGREN J
DATE OF ORDER:
14 FEBRUARY 2003
WHERE MADE:
SYDNEY
THE COURT ORDERS THAT:
1.The proceeding be stood over to 11 March 2003 for the making of orders, including orders as to costs.
2.The parties supply to the Associate to Lindgren J by 7 March 2003 an agreed form of orders or, failing agreement, the forms of orders for which they respectively contend and written submissions in support of those orders.
Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.
SPASSKED PTY LIMITED v COMMISSIONER OF TAXATION
(N1362 of 1999)STANLEY PARK LIMITED v COMMISSIONER OF TAXATION
(N1363 of 1999)INDUSTRIAL EQUITY LIMITED v COMMISSIONER OF TAXATION (N1364 of 1999)
Table of Contents
INTRODUCTION........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ... [1]-[11]
GENERAL BACKGROUND FACTS........ ........ ........ ........ ........ ........ ........ ........ [12]–[28]
THE SPASSKED STRUCTURE........ ........ ........ ........ ........ ........ ........ ........ ........ . [29]-[44]
FRANKED AND UNFRANKED DIVIDENDS........ ........ ........ ........ ........ ........ ........ ....... [30]
SECTION 46 “DIVIDEND REBATES”........ ........ ........ ........ ........ ........ ........ ........ . [31]–[32]
TAX LOSSES........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ... [33]
DIVIDEND TRAPS........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ . [34]–[36]
COMPANY LAW AND TAX LAW TREATMENT OF LOSSES........ ........ ........ ...... [37]–[38]
THE CHANGES MADE BY THE SPASSKED RESTRUCTURING........ ........ ....... [39]–[44]THE RESPECTIVE PARTIES’ STATEMENTS
OF FACTS, ISSUES AND CONTENTIONS........ ........ ........ ........ ........ ........ .... [45]–[58]MORE DETAILED EVIDENCE OF THE FACTUAL BACKGROUND... [59]–[138]
THE IEL GROUP........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ... [61]–[62]
BUSINESS MANAGEMENT/ADMINISTRATION AND PLANNING ROLE........ . [63]–[64]
HEAD OFFICE MANAGED COMPANIES
AND EXTERNALLY MANAGED COMPANIES........ ........ ........ ........ ........ ........ .... [65]–[67]
DIVIDEND RECOMMENDATIONS........ ........ ........ ........ ........ ........ ........ ........ ...... [68]–[70]
ADMINISTRATION TEAM MEETINGS........ ........ ........ ........ ........ ........ ........ ........ ........ . [71]
STRUCTURAL CONCERNS........ ........ ........ ........ ........ ........ ........ ........ ........ ........ .. [72]–[74]
INTRODUCTION OF THE DIVIDEND IMPUTATION SYSTEM........ ........ ........ ........ . [75]
DIVIDEND TRAPS........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ . [76]
WASTAGE OF TAX LOSSES........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ .. [77]
THE SPASSKED PROPOSAL........ ........ ........ ........ ........ ........ ........ ........ ........ ........ [78]–[81]
EXPECTATIONS IN RESPECT OF THE SPASSKED RESTRUCTURING........ .. [82]–[90]
IMPLEMENTATION OF THE SPASSKED STRUCTURE........ ........ ........ ........ .. [91]–[106]
INTEREST........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ .. [107]–[110]
INVESTMENT BY SUBCOS........ ........ ........ ........ ........ ........ ........ ........ ........ ....... [111]–[112]
FRANKED AND UNFRANKED DIVIDENDS........ ........ ........ ........ ........ ........ ... [113]–[114]
TAKEOVER OF IEL BY THE ADSTEAM GROUP IN NOVEMBER 1989....... [115]–[124]
PAYMENT OF DIVIDENDS BY GIH TO SPASSKED........ ........ ........ ........ ........ ........ . [125]NEGOTIATIONS WITH AUSTRALIAN TAXATION OFFICE........ ........ ........ .. [126]–[132]
LIQUIDATION PROJECT........ ........ ........ ........ ........ ........ ........ ........ ........ ........ . [133]–[136]
DIVIDENDS PAYABLE........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ [137]
AGREEMENTS FOR THE PURPOSES OF s 80G OF THE ACT........ ........ ........ ....... [138]REASONING........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ .... [139]–[246]
COMPETENCY........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ .. [139]–[157]
SUBSECTION 51(1)........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ... [158]–[245]
General legal principles........ ........ ........ ........ ........ ........ ........ ........ ........ .... [158]–[192]
General........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ... [158]–[159]
Deductibility of interest on money borrowed........ ........ ........ ........ ........ . [160]–[162]
Expectation or purpose........ ........ ........ ........ ........ ........ ........ ........ ........ ... [163]–[169]
Holding companies........ ........ ........ ........ ........ ........ ........ ........ ........ ........ . [170]–[180]
Subjective and objective expectations and purposes........ ........ ........ ...... [181]–[186]
Tax considerations as a motive........ ........ ........ ........ ........ ........ ........ ...... [187]–[190]
Magna Alloys........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ .... [191]
Steele........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ . [192]The facts........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ..... [193]–[245]
Spassked’s general course of borrowing from IEF........ ........ ........ ........ [193]–[194]
Four general matters........ ........ ........ ........ ........ ........ ........ ........ ........ ...... [195]–[198]
Particular circumstances........ ........ ........ ........ ........ ........ ........ ........ ........ ........ .. [199]
The question of expectation (in the positive sense explained at
[164]–[166]) or purpose to be determined as at mid 1987 to
28 June 1990........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ..... [200]
Testimony of Daniels and Cottam........ ........ ........ ........ ........ ........ ........ .. [201]–[236]
Summary........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ . [237]–[245]PART IVA ISSUES........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ [246]
CONCLUSION........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ . [247]–[249]
ANNEXURE “A” Diagram illustrating Spassked Restructuring........ ........ ........ ........ [41]
ANNEXURE “B” Diagrams illustrating eleven transactions........ ........ ........ ........ .... [105]
ANNEXURE “C” Table of investments made by GIH in Subcos ........ ........ ........ .... [111]
IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY
N 1362 OF 1999
BETWEEN:
SPASSKED PTY LIMITED (ACN 003 255 847)
APPLICANTAND:
COMMISSIONER OF TAXATION
RESPONDENT
IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY
N 1363 OF 1999
BETWEEN:
STANLEY PARK LIMITED (ACN 008 432 997)
APPLICANTAND:
COMMISSIONER OF TAXATION
RESPONDENT
IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY
N 1364 OF 1999
BETWEEN:
INDUSTRIAL EQUITY LIMITED (ACN 004 617 164)
APPLICANTAND:
COMMISSIONER OF TAXATION
RESPONDENT
JUDGE:
LINDGREN J
DATE:
14 FEBRUARY 2003
PLACE:
SYDNEY
REASONS FOR JUDGMENT (No 5)
introduction
These three proceedings involve appeals by taxpayers against what the applicants contend are appealable objection decisions under s 14ZZ of the Taxation Administration Act 1953 (Cth) (“the Administration Act”). The objection decisions were decisions by the respondent Commissioner (“the Commissioner”) to disallow objections by the applicants dated 9 May 1997 to their respective assessments of income tax, notices of which were issued on 14 March 1997 for the year ended 30 June 1992 (“the 1992 year of income” and “the 1992 year”).
As explained below, three amounts totalling $932,667,411 were claimed by the three applicants as allowable deductions against their assessable incomes for that year. But I was informed that similar circumstances also prevailed in each of the six years ended 30 June 1988, 1989, 1990, 1991, 1993 and 1994. Apparently the total amount of the deductions claimed in respect of all seven years by all companies which the Commissioner has disallowed and which involve the issues that arise for decision in these proceedings, is $6,527,082,709.
The applicant in proceeding N 1362 of 1999, Spassked Pty Limited (“Spassked”) and the applicant in proceeding N 1363 of 1999, Stanley Park Limited (“SPL”), were, at material times, wholly owned subsidiaries of the applicant in proceeding N 1364 of 1999, Industrial Equity Limited (“IEL”). Nearly all of the other companies to which I will have occasion to refer were also wholly owned subsidiaries of IEL, and therefore part of “the IEL Group” (or “the Group”).
For the 1992 year Spassked returned a loss of $873,511,525. By his notice of assessment issued on 14 March 1997, the Commissioner disallowed a deduction claimed by Spassked for interest paid by it to IEL Finance Limited (“IEF”) of $888,165,526, resulting in an adjusted taxable income of $14,654,001. According to the notice of assessment, Spassked was assessed to tax on this amount in a sum of $5,715,060.39, but after allowing for a credit of $5,715,060.39, the balance of the assessment, and the amount payable, were both “$0.00”.
There were two grounds on which the Commissioner disallowed Spassked’s claim to deduct the interest of $888,165,526 paid to IEF. The first was that it was not deductible under either of the two positive limbs of subs 51(1) of the Income Tax Assessment Act 1936 (Cth) (“the Act”). Whether it was so deductible is the first major issue in the case. The second ground was that if it was so deductible, the Commissioner had made a determination on 10 March 1997 for the purposes of par 177F(1)(b) of the Act that the whole of the interest should not be an allowable deduction. Whether the Commissioner’s purported determination under par 177F(1)(b) was effective is the second major issue in the case.
The issues which arose in the SPL and IEL proceedings were consequential on those in the Spassked proceeding. On the basis that Spassked was entitled to an allowable deduction of $888,165,526 in respect of the interest paid to IEF, and therefore sustained the loss of $873,511,525, it transferred a loss of $109,360 to SPL and a loss of $44,392,525 to IEL pursuant to subs 80G(6) of the Act (see [33] below). But since, in accordance with the Commissioner’s assessment of Spassked, those amounts of loss had not been incurred by Spassked, they were not available to be transferred by it. Therefore, the Commissioner disallowed in his assessments in respect of SPL and IEL the amounts of the losses claimed by them as deductions. In the case of SPL, this had the effect that its taxable income for the 1992 year as returned of $88,605,000 was increased by $109,360 to $88,714,360. In the case of IEL, it had the effect that its taxable income for the 1992 year as returned of $225,266,618 was increased by $44,392,525 to $269,659,143. On 12 March 1997 the Commissioner made determinations under par 177F(1)(b) of the Act in respect of SPL and IEL.
The grounds of disallowance in the case of each of SPL and IEL were also two: first, that in terms of subs 80G(6) of the Act, the claimed loss purportedly transferred to the taxpayer was not an allowable deduction; and, secondly, that if it was, the Commissioner had made a determination on 12 March 1997 for the purposes of par 177F(1)(b) of the Act that the loss transferred should not be an allowable deduction. These two grounds gave rise to two issues in each of the SPL and IEL proceedings, which mirrored those in the Spassked proceeding referred to above.
Determination of the two issues in the Spassked proceeding will determine those in the SPL and IEL proceedings. For this reason, I will later generally find it convenient to refer to Spassked as if its appeal were the only one before the Court.
On 9 May 1997 each of Spassked, SPL and IEL gave notice of objection against its assessment. On 19 November 1999 the Commissioner gave each of them a “notice of decision on objection” indicating that its objection had been disallowed.
All three of the present proceedings were commenced on 22 November 1999.
There is a further issue in the Spassked proceeding. The Commissioner contends that Spassked’s appeal is not properly constituted because there was no “objection decision”. This contention, which has no application in the SPL and IEL proceedings, arises from the fact that the assessment in respect of Spassked was a “nil” assessment.
general background facts
IEL was incorporated pursuant to the Companies (Victoria) Code 1961 on 11 November 1964. In June 1966 a majority shareholding in IEL was acquired by a company associated with Mr Ronald Brierley (“Brierley” – later Sir Ronald Brierley) who became chairman of IEL immediately following the takeover. Brierley remained chairman until 1990. Since at least 1973, IEL’s investment policy followed Brierley’s policy of “expansion by acquisition”: the acquisition of companies thought to be undervalued by the market relative to the value of their underlying assets and business operations, followed by the taking of steps to realise that value.
This policy proved to be successful and the IEL Group expanded. Over the years of income 1974 to 1987, IEL’s consolidated net profits after tax grew from approximately $1.1 million to approximately $230 million, the number of subsidiary companies IEL controlled expanded from 117 to 591, and the number of employees of the Group rose from approximately 850 to approximately 23,000 people.
The IEL Group was managed by a small number of executives and staff who were encouraged by Brierley to deal with each other on a face to face basis and who were discouraged from generating what Brierley perceived to be unnecessary paper work. Accordingly, despite the growth in size and earnings of the Group during the period of fifteen years down to 1987, the approximate number of head office staff (including administrative staff) increased from only sixteen to only thirty people.
From about 1983 the management of the Group was divided into two main areas. The first concerned the acquisition, management and disposal of its investments. This was under the control of an “Investment Team”. The other concerned the implementation of decisions of the Investment Team, as well as the day to day administrative and regulatory affairs of the Group. This area was under the control of an “Administration Team”. The Investment Team and the Administration Team held informal daily meetings.
In about 1978 IEL ceased acquiring investments in its own name. Instead, its subsidiary companies commenced doing so.
The IEL Group borrowed from external sources to fund its acquisitions. In 1985 IEF commenced acting as the in-house finance company for the Group. By that time the use of an in-house finance company had become a common feature of the corporate group business scene because of the savings and benefits associated with the centralisation of funds management within one entity.
For a short time IEF lent to and borrowed from other IEL subsidiaries at rates which enabled it to recover its own costs. Later, however, it increased the interest rates it charged to other Group companies so that it obtained a slight margin on its activities.
By late 1986 the shareholding and debt lines within the IEL Group were complex, even when compared to those of other large corporate groups operating in Australia at the time. The complexity arose in part because of a policy adopted as from 1978 (referred to in [16] above) that any new investment should be acquired by a specific subsidiary dedicated to the purpose. This led to a proliferation of subsidiaries. Moreover, in some cases pre-existing complex structures had been “inherited” as a result of takeovers.
I will discuss below the purposes and effect of the adoption in late 1987 of a new structure in which Spassked was centrally involved (respectively, “the Spassked Restructuring” and “the Spassked Structure”). Briefly, it was a matter for concern at that time that there were “dividend traps” within the Group, arising from the fact that intermediate holding companies had expenses (in particular, interest on their borrowings) against which any dividends received by them had to be applied before the amount of any profit or loss could be determined. This had two potentially damaging consequences for the Group: first, it prevented the free flow of dividends up to the ultimate holding company, IEL, and to its shareholders; secondly, if the taxable income of the recipient company was less than the amount of the dividend it received (by reason, for example, of the size of current interest expenses or losses carried forward from past years), part or all of the intercorporate dividend rebate otherwise available under s 46 of the Act in respect of the dividends would be lost. The dividends would be trapped, and any associated s 46 rebate foregone, in the recipient company.
The applicants submit that there were four purposes of the adoption of the Spassked Structure (the second and third are related):
· the simplification of the Group’s corporate debt and equity lines;
· the avoidance of the dividend traps described;
· the avoidance of the foregoing of s 46 tax rebates; and
· the ready availability, as vehicles through which new acquisitions could be made, of a range of subsidiary companies with various levels of paid up capital.
The Commissioner, on the other hand, contends that the purposes of the adoption of the Spassked Structure were the related ones of eliminating dividend traps (and the associated foregoing of s 46 rebates) and exploiting to maximum advantage the possibility of transferring losses, by centring interest expenses, and therefore losses, in a corporate vehicle dedicated to that purpose (Spassked), from which the losses could be transferred to other members of the IEL Group, as seemed, to those in control, in the interests of the Group as a whole from a tax viewpoint.
The Spassked Structure was put in place in late December 1987 and was used in a series of transactions from then to June 1990.
On or about 20 November 1989 ownership and control of the IEL Group passed to a group of three companies: The Adelaide Steamship Company Ltd, David Jones Ltd and Tooth & Co Ltd (collectively, “the Adsteam Group”). Each of these companies held a one third shareholding in various subsidiaries, one of which was Dextran Pty Ltd (“Dextran”). It was Dextran which acquired all the issued shares in IEL.
Following the takeover by the Adsteam Group, in February 1990 Mr Spalvins of the Adsteam Group replaced Brierley as chairman of IEL. On or about 18 June 1990 shares in IEL were suspended from official quotation on the Australian Stock Exchange (“ASX”).
By as early as about November 1990, the Adsteam Group was experiencing difficulties in meeting its debt commitments. On or about 4 November 1990, the Adsteam Group and IEL announced to the ASX that an “in principle” agreement had been reached with the bankers to the Adsteam Group on a comprehensive program of restructuring and rationalising the Group’s financial and capital base. Over the 1992 to 1997 financial years Dextran borrowed from IEL amounts totalling $2,037,702,786. In sum, from about November 1990, the IEL Group was in de facto administration and there was little or no chance of its continuing as a going concern.
In 1994 the Spassked Structure was “wound up” when Spassked borrowed from GIH, and to a small extent from IEL, in both cases interest free, and used the borrowed funds to pay out its debt to IEF in full, that is to say, to pay both the capital sums it had borrowed from IEF and the capitalised interest on its borrowings. From that time, GIH was Spassked’s creditor in place of IEF, but, unlike IEF, was not charging Spassked interest.
The parties having an interest, in practical terms, in the outcome of the three proceedings are certain banks as creditors of the members of the Adsteam Group, and, of course, the Commissioner.
the spassked structure
In order to understand the rationale and effect of the Spassked Structure, it is necessary to understand the legislative and factual background to its adoption in the latter half of 1987.
Franked and unfranked dividends
“Dividend imputation” was introduced on 1 July 1987 and so was first applicable in the tax year ended 30 June 1988. It was intended to give shareholders who were natural persons and who received a dividend, a credit for any tax which had been previously paid on the dividend by the company. Under the new régime a dividend would carry or not carry the benefit of such a credit, according to whether tax had or had not been paid on the dividend before it was received by the individual. A dividend that carried that benefit was “franked” and a dividend that did not carry it was “unfranked”. Clearly, as between two dividends of the same amount, an individual would prefer to receive a franked dividend because he or she would be entitled to a rebate off his or her own tax liability to the extent of the franking credit attached to the dividend. A franking credit could be passed up through a line of companies through the ultimate holding company to its natural person shareholders.
Section 46 “dividend rebates”
Section 46 of the Act provided for a full rebate of the amount of tax which would otherwise be payable on a dividend paid by one resident public company to another resident public company. (IEL and its subsidiaries were resident public companies – see s 46(2)(b); subs 6(1) (definition of “private company”); subss 103A(1), 103A(2)(a) and 103A(2)(d)(v).) Prior to the introduction of imputation, subs 46(7) had the effect that the amount of the rebate was reduced by reason of a requirement that for the purpose of calculation of the amount of the rebate, there be set off against the amount of the dividend the amount of any interest expense directly referable to it. But following the introduction of imputation, the set off no longer applied. Accordingly, for the year ended 30 June 1988, the amount of the rebate was simply the amount of the tax payable on the dividend received.
What is of immediate importance is that the “rebate” was of an amount of tax that would have been payable by the recipient of the dividend on the amount of the dividend. Accordingly, for the rebate to operate, there had to be tax payable by the recipient of the dividend, and the amount of the rebate could not exceed the amount of that tax. If the dividend recipient’s allowable deductions exceeded its assessable income (including the dividend), it would have no taxable income and so there would be no tax payable against which any rebate could operate. In that situation the benefit of the tax rebate made available by s 46 would be foregone.
Tax losses
The Act’s provisions for the deductibility of losses were complex. All that need be said for present purposes is that, in general terms and omitting qualifications: a taxpayer incurred a loss for tax purposes when its allowable deductions exceeded its assessable income and net exempt income (subs 80(1)); losses incurred in any of the seven years next preceding the year of income could be “carried forward” in the sense that they were “allowable deductions” in the year of income (subs 80(2)); and as between resident companies in a group, such as the IEL Group, losses could be transferred by a “loss company” in the group to an “income company” in the group, so that the loss was deemed to have been incurred by the income company (subs 80G(6)). It was necessary that, but for the transferred loss, the income company have a taxable income. Transfer was effected under subs 80G(6) by an agreement which was required to be in writing: subs 80G(6A).
Dividend traps
As noted earlier, prior to the Spassked Restructuring there were dividend traps within the IEL Group. Assume a subsidiary company whose only income was in the form of dividends and whose outgoings for interest on borrowings exceeded the amount of those dividends. The subsidiary would have no current year’s profit from which it could pay a dividend. Unlike s 46 dividend rebates and “tax losses”, this was a matter of company law rather than tax law. Section 565 of the Companies Code and its successor s 201 of the Corporations Law prohibited payment of dividends except out of profits. Accordingly, a company which had made a loss rather than a profit could not, in effect, “stream” or “pass” up the line any dividends it received from companies below it (or, therefore, any franking credits attached to such dividends). Not only would a dividend received by the company and any franking credit attached to it be “trapped” within the company: the company would not be entitled to a s 46 rebate. The reason is that it would have no taxable income and so there would be no amount of tax to be rebated.
Being unable to take advantage of the s 46 rebate did not matter to the dividend trap company itself, because either way its taxable income was nil. But it mattered to the Group as a whole. The Group was worse off than it would have been if the interest expense had been incurred by another Group member which was not a recipient of the dividend income. In that case the company which received the dividend would have a taxable income and so be in a position to take advantage of the s 46 rebate. As well, it would be in a position to pay a dividend and so to pass up the line any franking credit attached to any dividend which it had received. Moreover, the interest incurring member of the Group would make losses which it could transfer to such other members of the Group, as might be in the interests of the Group, to form deductions against their assessable income.
In sum, dividend traps could be avoided and the benefits of s 46 rebates and of the carry forward loss and group loss transfer provisions could be obtained, if the incurring of the expenses and the receipt of dividends were separated so that they took place in different companies.
Company law and tax law treatment of losses
As noted above, s 565 of the Companies Code and its successor s 201 of the Corporations Law prohibited the payment of dividends except out of profits (the current section is s 254T of the Corporations Act 2002 (Cth)). The Australian legislation has not defined “profits” for this purpose, leaving the matter to the general law and the evidence of accountants and others as to commercial practice. Although sound accounting practice may be otherwise, past years’ losses are not required by law to be made good before it can be said that there is a current year’s profit distributable by way of dividend: Ammonia Soda Co Ltd v Chamberlain [1918] 1 Ch 266; Marra Developments Ltd v BW Rofe Pty Ltd [1977] 2 NSWLR 616 at 630. A fortiori, a transferee under s 80G of the Act of losses within a group was not required to deduct them in determining whether it had such a current year’s distributable profit.
Thus, while Spassked was required by law to deduct the interest which accrued due to IEF in the year of income in order to determine whether it had a distributable profit for that year, it was not required to deduct past years’ losses for that purpose. But for tax purposes it was required to deduct past years’ losses in determining whether it had a taxable income for the year (“taxable income” was defined in subs 6(1) as, relevantly, “the amount remaining after deducting from the assessable income all allowable deductions”). Similarly, if Spassked transferred an amount of loss to another company in the Group, the transferee likewise would not have to deduct that amount in order to determine if it had a distributable profit for the current year, but for tax purposes it would be required to deduct the amount in order to determine if it had a taxable income for that year.
The changes made by the Spassked Restructuring
The following is a simplified and general account of the changes made by the Spassked Restructuring. Previously, direct subsidiaries of IEL were the Group’s investment vehicles, making investments and borrowing for that purpose from the Group’s in-house banker or financier, IEF. Under the Spassked Structure, two subsidiaries of IEL, Spassked and Group Investment Holdings Pty Ltd (“GIH”), were interposed between both IEL and IEF on the one hand and the investing subsidiary (“Subco”) on the other. Spassked and GIH were both incorporated in New South Wales on 17 March 1987 (Spassked and GIH having had different names at first, to which I need not refer further). Spassked was to be the borrowing member of the Group; GIH was to be an intermediate parent company in the Group.
IEL owned all the issued shares in Spassked (and in IEF). IEL and Spassked owned the issued shares in GIH as follows:
(a)Spassked held A Class shares (“A” shares) which entitled it to franked and unfranked dividends, full voting rights and participation in any surplus on a winding up;
(b)IEL held B Class (“B” shares) shares which entitled it to franked dividends only, limited voting rights and no right to participate in any surplus on a winding up.
The diagrams attached as Annexure “A”, based on diagrams provided by the Commissioner, show, in simplified form, the respective positions before and under the Spassked Structure.
As can be seen, both before and under the Spassked Structure, IEF borrowed externally and “on-lent” to a member of the Group at a higher rate of interest. But pre-Spassked, it was the direct subsidiary of IEL which borrowed from IEF and made the underlying investment, whereas under the Spassked Structure, Spassked borrowed from IEF and used the money borrowed to subscribe for “A” shares in GIH, which, in turn, subscribed for shares in the Subco, which, in turn, made the underlying investment in, commonly, shares in listed public companies.
The company designated “Subsidiary” in the pre-Spassked diagram is a dividend trap because it has borrowed from IEF and is accruing interest to IEF equal to or exceeding the amount of the dividend it received: the whole of the dividend is trapped in the Subsidiary and cannot be passed upstream. But in the post-Spassked diagram this is no longer the case: the investing subsidiary is able to pass up the dividend it receives to GIH which also has not borrowed at interest from IEF. There is the possibility of GIH paying a dividend because it has made a profit. And if the dividend it has received is franked, it can pass on the franking credit. Finally, post-Spassked, advantage can be taken of the s 46 rebate because both the Subco and GIH do incur a tax liability on, if nothing else, the dividends they have received. In the simple case where their only income is a franked dividend, they can, in effect, “transmit” that dividend with the franking credit upwards, in the case of the Subco to GIH and in the case of GIH to IEL (or, but for the dividend trap problem, to Spassked) without having had to pay tax on it because of the s 46 rebate.
The applicants contend that the Spassked Structure was “tax neutral” because the interest claimed as a deduction by Spassked was shown as assessable income in the hands of IEF, and, the applicants submit, if it had not been, IEF would have suffered losses which it, rather than Spassked, could have transferred to other members of the Group. But the Commissioner replies that for the purposes of the Group as a whole, the Spassked Structure was not tax neutral and was very “tax beneficial” to the Group.
the respective parties’ statements of facts, issues and contentions
From 30 December 1987 to 28 June 1990, that is, in the three years of income 1988, 1989 and 1990, IEF provided Spassked with financial accommodation in amounts totalling $3,737,142,866 (see [100] below). The financial accommodation was not:
· provided under any written agreement between IEF and Spassked;
· recorded in any minutes of either IEF or Spassked; or
· the subject of any formal resolutions of the board of directors of either IEF or Spassked.
Spassked’s decisions to subscribe for shares in, or lend money to, GIH, and GIH’s decisions to allot shares to, or borrow money from, Spassked were not:
· recorded in any minutes of either Spassked or GIH; or
· the subject of any formal resolutions of the board of directors of either Spassked or GIH.
The amounts of interest payable by Spassked to IEF on the financial accommodation provided by IEF to Spassked were capitalised every six months in the books of account, by being added to the balances owing by Spassked to IEF. They totalled $3,272,715,111 for the seven years of income down to the time when Spassked’s indebtedness to IEF was discharged (see [107] below for the individual amounts).
In the period from 1 July 1987 to 30 June 1994:
(a)the Subcos received “rebateable dividends” from their investments in listed and unlisted company shares;
(b)Spassked received only a small fraction of those dividends.
In fact, in that period, according to the financial records of Spassked and GIH, Spassked was paid only the following two dividends (both unfranked) by GIH:
For year ended Amount ($) 30 June 1990 29,308,093 30 June 1992 14,654,046
--------------Total 43,962,139
========(For the year ended 30 June 1990, Spassked was also paid a franked dividend of $182,079 by GIH, making a total of the dividends paid to it for that year of $29,490,172, and an overall total of $44,144,218, but later records show a “correction” to exclude that amount and to credit it to IEL. I shall proceed on the basis of the corrected position.) In the same period, IEL received $33,378,828 in franked dividends from GIH, representing, but for a $3.00 discrepancy (which I will henceforth ignore), all the franked dividends GIH had received from its Subcos in that period.
In the same seven year period, as a result of its liability to IEF for interest, Spassked incurred losses which it purported to transfer to other members of the IEL Group pursuant to s 80G of the Act. By 1998 Spassked had transferred all its losses.
The Commissioner points to the disproportion between Spassked’s interest expenses to IEF of $3,272,715,111 over the seven year period and the dividends it derived from GIH over that period of only $43,962,139, and submits that Spassked was, and was always intended to be, a dedicated borrowing and loss making and loss distributing centre within the Group, and was not, and was never intended to be, a recipient of assessable income.
In his Further Amended Statement of Facts, Issues and Contentions, the Commissioner identified “the purported effect” of the series of transactions. According to the Commissioner, that purported effect was to create, or to continue, an interest expense in Spassked and to remove or offset an interest expense that would otherwise have been incurred by a Subco, or by a particular identified Subco. In the case of one transaction, the Commissioner contended, in the alternative, that “the purported effect” was to avoid the operation of subs 51(6) and/or s 79D of the Act.
The Commissioner contended that the amount of $888,165,526, claimed by Spassked as an allowable deduction for the 1992 year, was neither “incurred in gaining or producing the assessable income” within the first positive limb of subs 51(1) of the Act, nor “necessarily incurred in carrying on a business for the purpose of gaining or producing such income” within the second positive limb of that subsection.
The Commissioner contended that Spassked borrowed the funds from IEF for other purposes which are expressed in alternative ways. He contended that Spassked borrowed for the purpose of “locating” the interest outgoing in Spassked. The Commissioner’s contentions continued as follows:
“2.Further or in the alternative ... , the amount of $888,165,526 is not an allowable deduction under s 51(1) of the Act ... because:
(a)there is a gross disproportion between the amount of the outgoings and the assessable income derived by Spassked from its investment in GIH in the 1991-92 year of income ($14,654,046);
(b)further, there is a gross disproportion between the amount of the outgoings allegedly incurred by Spassked in the period from 1 July 1987 to 30 June 1994 ($3,272,715,109 [sic]) and the assessable income derived by Spassked from its investment in GIH in that period ($44,144,218 [see [48] above – $43,962,139]);
(c)the gross disproportion is to be explained by the pursuit by Spassked, in the obtaining of loans and other financial accommodation from IEF and in its investments in (and loans to) GIH, of an objective other than the gaining or producing of assessable income;
(d)the independent objective of incurring the interest expense was to benefit other companies in the IEL Group from whom Spassked could not derive assessable income by creating tax advantages for those companies.
3.Further or alternatively to paragraph 2(d), the independent objective of incurring the interest expense was to:
(a)create an interest expense in Spassked and to remove or offset an interest expense in a Subco so that the rebate on dividends received or expected to be received by the Subco would not be reduced as a result of that company claiming allowable deductions for that interest expense;
(b)ensure that non-rebateable assessable income derived by a company (other than Spassked) is reduced by interest deductions (in the form of s 80G loss transfers) which would otherwise have been reduced or offset by rebateable assessable income in some other company.
4.Further or alternatively to paragraph 2(d), the independent objective of incurring the interest expense was to:
(a)create or continue an interest expense in Spassked and to remove an interest expense in [the Subco, Harbourfort Pty Ltd – called “IDE”, an acronym based on its former name] so that the rebate on dividends received or expected to be received by IDE from [Woolworths Ltd – called “WLW”] would not be reduced as a result of IDE claiming allowable deductions for that interest expense;
(b)ensure that non-rebateable assessable income derived by IDE is reduced by interest deductions (in the form of s 80G loss transfers) which would otherwise have been reduced or offset by rebateable assessable income.
5.Further or alternatively to paragraph 2(d), the independent objective of incurring the interest expense in respect of the loan described in paragraph 17(a) above [a reference to a loan on or about 31 March 1988 in the amount of $675,000,000 from IEF to Spassked – see [100] below] was:
(a)to avoid the operation of s 51(6) of the Act; and/or
(b)to avoid the operation of s 79D of the Act.”
In relation to the issue of the effectiveness of the s 177F determination, the Commissioner’s contention was as follows:
“6.... , the amount of $888,165,526 is not allowable as a deduction ... because a delegate of the Commissioner determined pursuant to s 177F of the Act that the sum was not allowable ... and the necessary conditions for the determination were satisfied as follows:
(a)Spassked obtained a tax benefit in connection with the scheme by the sum of $888,165,526 being allowable as a deduction to Spassked ... where the whole or part of that sum would not have been allowable as a deduction, or might reasonably be expected not to have been allowable, ... if the scheme had not been entered into or carried out;
(b)the scheme was constituted [as described in the Commissioner’s document – I will not summarise the description here];
(c)having regard to the matters in s 177D(b) of the Act, it would be concluded by a reasonable person that the scheme or part of the scheme was entered into or carried out by a person for the dominant purpose of enabling Spassked to obtain the tax benefit in connection with the scheme; ...”
Spassked identified the issue as to the effectiveness of the s 177F determination as follows:
“19.Whether the respondent made and was entitled to make a determination pursuant to s 177F(1)(b) of the Act that the whole of the amount of $888,165,526 is not allowable as a deduction to Spassked ... and in particular whether:
(a)a ‘scheme’ within the meaning of s 177A(1) of the Act was entered into or carried out;
(b)Spassked obtained a ‘tax benefit’ within the meaning of s 177C(1) of the Act in connection with any such scheme;
(c)it would be concluded on the basis of the matters referred to in s 177D(b) of the Act that one of the persons who entered into or carried out the scheme or any part of the scheme did so for the dominant purpose of enabling Spassked to obtain that tax benefit in connection with the scheme;
(d)the making of the Determination was a proper exercise of the respondent’s discretion under s 177F(1) of the Act.”
Spassked contended that the motivation or subjective object or purpose of a taxpayer is irrelevant to Part IVA and is generally irrelevant to both positive limbs of subs 51(1). In particular, Spassked contended that it is irrelevant that those concerned in the adoption of the Spassked Structure may have been motivated by tax considerations. According to Spassked, the criterion of deductibility was the objective one of whether the interest expense arose from a borrowing of money which Spassked, as a holding company, used to fund the making by GIH and the Subcos of investments which were inherently capable of generating income for Spassked.
In relation to the “gross disproportion” which the Commissioner said existed between the aggregate amount of interest expense Spassked incurred ($3,272,715,111) and the relatively small amount of dividend income Spassked received ($43,962,139), Spassked contended that all that mattered was whether it borrowed money for the purpose of acquiring shares capable of producing dividends. Spassked further argued that, although it had received from GIH dividends of only $43,962,139 down to 30 June 1992, in the ordinary course of events it would have received more, indeed, it would have received dividends sufficient to enable it, perhaps with a return of capital from some of the investments, to discharge its liability to IEF. But Spassked asserted that the “ordinary course of events” did not take place for two reasons. The first was the acquisition of IEL by the Adsteam Group in November 1989, followed, a year later, by the Adsteam Group’s financial difficulties and the de facto administration of IEL referred to earlier. The second was the challenge or threatened challenge by the Commissioner to the deductibility of Spassked’s interest expenses to IEF and of the losses purportedly transferred by Spassked to other members of the Group, and the consequential unwillingness of directors of any of the transferees to stream up dividends against the possibility that the Commissioner’s stance might be sustained.
The Commissioner contended that, as was always intended, Spassked was not in the business of generating assessable income and was in fact only in the “business” of generating losses. The Commissioner pointed out that if Spassked had been in the business of generating assessable income in the form of a stream of dividends from GIH, those dividends would have been caught in the largest dividend trap in the Group, in view of the large amount of interest Spassked was incurring on its borrowings from IEF.
more detailed evidence of the factual background
Many of the facts in the case were established by a lengthy affidavit of Ross Daniels (“Daniels”) who was a management accountant employed by IEL from early 1974 to June 1994, when he accepted a redundancy offer. For much of that time he was the senior management accountant of the IEL Group. After his period of employment by IEL, Daniels was retained by IEL as a consultant accountant from late 1994 down to the time of the hearing. Daniels was centrally involved in devising and implementing the Spassked Structure. Similarly involved, though to a lesser extent in some respects, was Gregory Kingston Cottam (“Cottam”), a chartered accountant, who joined the IEL head office as a “Tax Manager” in June 1987 when the devising of the Spassked Structure was already well under way, and six months before its approval in December 1987. Cottam was also called as a witness by Spassked. Much of what follows is based on their affidavits, particularly those of Daniels.
Daniels was at pains to establish the modus operandi of those who conducted the day to day operations of the IEL Group, and, in particular, the closeness of the individuals concerned and the informality of their procedures. For this reason, I will give a more extensive account of the evidence of the factual background than I might otherwise feel compelled to do.
The IEL Group
IEL was a share investment company, first incorporated as an unlisted company in 1964 in Victoria. It was acquired in 1966 by Citizens and Graziers Life Assurance Co Ltd, a wholly owned subsidiary of the New Zealand company, RA Brierley Investments Ltd. When Daniels joined IEL in early 1974 it was listed on the ASX and was a holding company of almost 120 Australian and New Zealand companies. In 1974 through its operating subsidiaries, then comprising about half the Group, IEL controlled a diverse range of operating businesses. The other half of the Group comprised mainly inactive or shelf companies held available for future investments or acquisitions.
Daniels was employed in IEL’s head office where some fifteen other IEL officers and staff worked. The head office was always small in relation to the rapidly increasing size of the IEL Group in the 1970s and 1980s. Daniels described “the main focus of head office staff” as facilitating the acquisitions or other investments which Brierley or other members of the Investment Team wished to make. The Investment Team comprised Brierley, certain senior officers of IEL, company analysts and various other staff from time to time. The Investment Team met regularly, often on a daily basis, from 1974 until about 1990. Head office staff, including, from about 1976, Daniels, were responsible for the financing and structuring of the companies that were to be used for the investments decided upon by the Investment Team. According to Daniels, from the early 1980s, he became “principally responsible for this investment support function”.
Business management/administration and planning role
By 1982 Daniels was one of the most senior employees of IEL, responsible for the management, planning and administration of the Group. Daniels stated:
“My administration and planning role involved me in identifying which head office company or entity should be used for a particular investment or acquisition under consideration. As part of this process, I determined the most appropriate means of funding an investment company, either by debt, equity or, on occasion, some combination of both. In doing so, I had regard to shareholding, accounting, corporate, legal, administrative and financial matters. I then took all steps necessary to facilitate the funding of the investment. This included raising capital for the venture, liaising with the IEL investment manager, the investment team and, where it was a significant investment, dealing with Sir Ronald Brierley or Mr Loewenthal [who became chief executive officer of IEL in 1973] (and later also Mr Russell Goward and Mr Rodney Price who became, respectively, the chief executive officer of IEL in 1984 and 1986), to ensure the investment team’s objectives were met. This aspect of my work became increasingly significant as the IEL group continued to expand.”
From about 1985 Daniels was a director of approximately 600 IEL subsidiaries.
Head office managed companies and externally managed companies
In 1974 IEL held about fifty or sixty non-income producing shelf companies and other companies which had once traded but had since become inactive. Generally, the shelf companies were companies which IEL had caused to be incorporated. The companies which had formerly traded were often companies which IEL had acquired, but which had become inactive following a post takeover restructuring. Generally, both types of company were held in readiness to make takeover bids or to exploit other investment opportunities. The Investment Team’s demand for such companies increased as the Group expanded through acquisitions from the mid 1970s to the late 1980s.
Daniels was principally responsible for IEL Group taxation matters until about 1985. He had become involved in those matters in the late 1970s. Over the succeeding years, he developed an understanding of the basic elements of Australian corporate taxation law. When he first became involved, IEL’s tax affairs were “relatively straightforward” and took up only a minor part of his time. But with the rapid expansion of the Group in the late 1970s and early to mid 1980s, and the “successive waves of company tax reform in Australia and New Zealand commencing in the mid-1980s”, he realised that he lacked the necessary time and expertise.
In about March 1984, Stephen Latham (“Latham”), a chartered accountant, became employed by IEL. He initially assisted Daniels, then gradually assumed management of the Group’s tax affairs. Over the next two to three years, Latham’s role broadened into one of assisting Daniels in handling some of the more complex management, accounting and planning issues, and the development of structured finance proposals. By the time Cottam joined IEL in June 1987, the Administration Team was already considering a restructuring of the Group, which became known as “the Spassked Structure”. Latham and Cottam consulted with Daniels regularly on taxation maters. Latham was not called as a witness.
Dividend recommendations
By the mid to late 1970s, having ceased to invest directly, IEL had become almost entirely reliant for income, and therefore for the means of giving a return to its own shareholders, on receiving dividends from its subsidiaries.
Daniels said that in about 1976 he became involved in calculating the funds of profits available from which dividends would be paid upstream, ultimately to IEL’s shareholders. He made dividend recommendations to the boards of directors of the relevant companies in the Group and to the IEL board itself. He stated that to the best of his recollection, his recommendations were accepted.
Cottam said that a “Review Group” comprising himself, Daniels, Latham, and a partner in the Group’s external auditors, met twice each year, usually in May and in November/December, for about a week, to review trial balances and to decide upon any dividend recommendations to be made.
Administration Team meetings
In 1983 regular Administration Team meetings, which were usually held following the daily Investment Team meetings, were instituted. Daniels was a member of the Administration Team from its inception and attended all its meetings between 1983 and 1994, except on the few occasions when he was out of the office, or during a period of ten months in 1990 when he was overseas. To the best of his knowledge, no minutes were made recording the proceedings of the meetings, which he described as “informal get togethers and an opportunity to discuss investments and issues associated with investments”. Cottam was also a member of the Administration Team.
Structural concerns
Paragraph 40 of Daniels’ affidavit was as follows:
“In late 1986 or early 1987, it became apparent to me that a restructure of the IEL group was necessary. I was concerned that the ad hoc way in which head office managed companies were selected and capitalised for investment purposes was not proving very effective or efficient, from either an administrative, planning, or economic viewpoint. It appeared to me that it was becoming increasingly difficult, because of the rapidly expanding nature of the group, to keep track of which company had made investments, and also to manage the IEL group’s investment portfolio as a whole. There also appeared to me to be a need to simplify the equity and, more particularly the debt lines between IEL group companies, which had become very complex due to a range of reasons, but principally the dramatic growth of the IEL group in the period 30 June 1974 to 30 June 1987. This is illustrated by the table below (which I have prepared following a review of IEL’s annual reports in this period).
IEL GROUP
Indicator 30 June 1974 30 June 1984 30 June 1985 30 June 1986 30 June 1987 Consolidated net profit after tax
$1.1 million
$26.312 million
$51.168 million
$145.271 million
$230.116 million
Number of consolidated group companies
117
245
299
365
591
Approximate total head office staff (including administrative staff)
16
30
26
30
30
Approximate total group employees
…850
15,000
16,000
23,000
23,000
Average shareholders funds
$8.9
million$104.8 million $181.0 million $488.7 million $1,007.9 million Return on average [shareholders’ funds]
12.5%
25.1%
28.3%
29.7%
22.8% ”
There were tendered in evidence three charts showing the debt lines and equity lines within the IEL Group at 30 June 1987. Daniels explained as follows in his affidavit:
“One of the main reasons why equity lines had become so complex by 1987, was because of the widespread use of a different company, or entity, for each investment or acquisition that was made by the IEL group. It was also attributable to the fact that in the case of quite a number of acquisitions, a whole corporate group was acquired, complete with holding companies, intermediate holding companies and operating subsidiaries. Often, these companies had pre-existing debt or equity lines that were maintained after their acquisition by the IEL group. Once incorporated within the IEL group, ongoing finance needs were often met by sources within the IEL group, which provided such funding via debt or equity. As a result, debt and equity finance was provided or used by companies at all levels across the IEL group.
In the case of debt lines, the complexity was attributable to similar historical factors. It was also attributable to attempts by myself and other members of the administration team to ‘match’ the companies which had acquired or were about to acquire assets likely to produce assessable income with the companies which had initially raised funds for the investment through external or inter-company loans. This was done for administrative and accounting reasons. By doing this we were also matching interest expenses that were allowable deductions with the earning of assessable income.”
Cottam also testified as to the complexity of the debt and equity lines within the Group. He also attributed this to the difficulties over the years of finding the most appropriate corporate entities within which to place new acquisitions and the most appropriate way of funding them, as well as to the fact that many of the companies involved were “inherited” as subsidiaries as a result of larger takeover transactions. I accept that the debt and equity lines were complex.
IEF was established as the in-house finance company of the Group in the mid 1980s. This development and the introduction of the company tax loss grouping provisions at about the same time made it possible to avoid a number of the problems referred to in pars 42 and 43 of Daniels’ affidavit set out in the immediately preceding paragraph. Daniels stated:
“… I was aware that tax losses could be transferred to wholly owned group companies that had earned assessable income. I was also aware that it was possible to reduce the number of debt lines and the consequential problems by funding companies by equity.”
Introduction of the dividend imputation system
Although the franking system was introduced with effect from 1 July 1987, its introduction was the subject of development announcements and its likely effect was being discussed in the business community from approximately late 1985. Daniels recalled that the need for IEL to pay franked dividends in order to satisfy its shareholders was “the subject of regular and detailed discussion at administration team meetings”. He stated:
“Reviewing the existing structure of the IEL Group and determining the need for any changes to it to facilitate the payment of franked dividends to shareholders was a task for which I assumed primary responsibility.”
IEL announced to its shareholders (of which Daniels was one) in about early 1987, its intention to pay franked dividends to any shareholder who wanted them. Daniels said he worked with the Administration Team members, including Latham and Cottam, towards ensuring that franked and unfranked dividends could be passed up to IEL so that it could meet its operating expenses and the expectations of its shareholders.
Dividend traps
Daniels stated as follows in his affidavit:
“... I had been involved in the flow of dividends up through the IEL group for a number of years. I also knew that the structure of the IEL group at that time did not readily support the flow of dividends up to IEL, even though IEL was still able to pay dividends. In any given year for instance, a number of IEL group companies inevitably made accounting losses. Typically, these companies were the intermediate holding companies of other IEL group subsidiaries that were profitable and able to pay dividends. This usually occurred because the holding company had borrowed to acquire equity in [or lend money to] the subsidiary. In turn, the subsidiary would use the [funds] raised to acquire income-producing assets. This left the parent company with a loss represented by interest on the borrowings. In consequence, the holding company’s financial statements or accounts, usually showed the holding company as having a net asset deficiency. This meant it had no fund of profits available from which to declare a dividend. This led to a multiplicity of ‘dividend traps’, as I called them, across the IEL group. This occurred because a dividend paid to a loss making parent company by a profitable subsidiary, could not be passed on to shareholders, until such time as it had a fund of distributable profits available.
If dividends received by a loss making holding company were fully or partially franked, any franking credits associated with them would also be trapped within the loss making entity. It was part of … my role to minimise the incidence of such dividend traps, so that dividends, franked and unfranked, could be passed up to IEL to enable it to meet expenses and pay dividends. This was increasingly difficult to achieve with the complexity of the IEL group at the time.”
Cottam also testified as to the dividend trap problems encountered in the Group prior to the Spassked Restructuring.
Wastage of tax losses
Daniels stated:
“Another matter that concerned me was the related problem of ‘wastage’ (as I saw it) of tax losses, which in commercial terms, represent an asset of the company concerned. My understanding of tax law at the time was that for tax purposes, a dividend received by a company had to be used first to offset tax losses incurred or carried forward in a given year. The payment of a dividend in such circumstances would result in the wastage of the tax loss asset. In effect, such wastage would reduce the wealth of shareholders in a company with current tax losses. It was part of my role to work with the IEL group tax manager to reduce the incidence of this occurring.”
Cottam testified that the benefit of the s 46 rebate was foregone where parent companies in the Group had losses which the Act required to be deducted from any dividend received by them before amounts of their taxable income and of tax payable could be ascertained, against the latter of which alone any rebate could be applied.
The Spassked Proposal
By late 1986 or early 1987, because of the concerns mentioned above, Daniels was convinced that an internal rationalisation was a “priority for the IEL Group”. To this end he had meetings and discussions with Latham from early 1987, and also, from mid 1987, with Cottam. They examined possible restructurings. As well, Daniels raised his concerns with the then chief executive officer, Rodney Francis Price (“Price”), who asked him to see what he could come up with.
Daniels discussed with Latham and Cottam the possibility of allotting to IEL “dividend access shares” in the various intermediate holding companies or trading subsidiaries, or both. The purpose of such an allotment would be to facilitate the payment of franked dividends to IEL, which it could “pass on” to its shareholders. Daniels said, however, that this would have complicated further the already complex shareholdings in the Group. Daniels said he saw it as an advantage to reduce the number of companies in which IEL had direct shareholdings.
According to Daniels, he, Latham and Cottam consulted a number of IEL Group company directors, employees and external advisers, including the Group’s auditors, and devised the Spassked Structure. In his affidavit he stated as follows:
The Spassked Proposal involved the following elements:
(a)Spassked (a wholly owned shelf company of IEL of which Mr Price, Dr Weiss [Dr Weiss was corporate counsel for the Group and a member of its Investment Team] and I were directors), would borrow funds from IEF (of which Mr Price, Dr Weiss and I, were also directors), at a commercial rate of interest, which was to be capitalised (by which I mean that the interest expenses that would be incurred by Spassked on its loans from IEF would be added to the principal and from that time also be subject to interest which would occur by crediting the interest income in the books of IEF, and debiting the interest expense in the books of Spassked);
(b)Spassked would use the funds borrowed from IEF to subscribe for ‘A’ class shares that would be issued by GIH (known, until 12 November 1988 as Bikinga Pty Limited, which was a wholly owned shelf subsidiary of Spassked, of which Mr Price, Dr Weiss and I, were directors). The articles of association of GIH would be changed so that it could allot ‘A’ class shares that would carry the right to both franked and unfranked dividends, and ‘B’ class shares that carried the right to franked dividends only;
(c)IEL would subscribe for ‘B’ class shares in GIH, entitling IEL to franked dividends only;
(d)GIH would use the subscription moneys received from Spassked and IEL to acquire shares in either:
(i)shelf companies or entities already held by the IEL group, or newly incorporated shelf companies; or
(ii)IEL group companies with existing assets, by subscription or purchase, that were expected to produce a franked dividend stream;
(e)Those companies referred to in subparagraph (d)(i) above would deposit their funds with IEF at interest, until such time as the funds were required for a specific offer, acquisition or investment. For those companies referred to in sub-paragraph (d)(ii), the funds would be applied to existing inter-company debt, and to the extent that there was a surplus of funds, this would be deposited with IEF at interest.”
In cross-examination, Daniels agreed that an additional element of the Spassked Structure was that Spassked would incur losses which it would transfer to other members of the Group.
Expectations in respect of the Spassked Restructuring
Daniels testified in his main affidavit about his expectations as to the outworking of the Spassked Restructuring.
It was proposed that most future acquisitions and investments by the Group would be made by the Subcos (which, with Spassked and GIH themselves, are referred to below as “the Spassked/GIH sub-group”). Daniels said he expected that the Spassked/GIH sub-group would invest in some pre-existing companies in the Group which were expected to pay franked dividends. He said he believed there was an “administrative advantage” in locating wholly owned subsidiaries of the Group within the Spassked/GIH sub-group so that the IEL Group could take advantage of the tax loss grouping provisions.
A matter which was the subject of cross-examination referred to below was the following assertion of Daniels:
“It was my intention in formulating the Spassked Proposal, that both Spassked and GIH would have their own requirements for income, and that both would ultimately receive dividends from their respective investments. As a director of Spassked and GIH, I was aware that relative to the size of the IEL Group, the Spassked Proposal would involve substantial sums of money being borrowed by Spassked from IEF at commercial rates of interest. I was also aware that Spassked, as a result of incurring these liabilities, would be likely to have losses in its early years.” (my emphasis)
Daniels knew that in the early years Spassked was likely to be a dividend trap, but saw it as an advantage of the Spassked Structure that one dividend trap would replace many. He said he believed that this would result in the Group being easier to manage. He continued in a passage which is at the heart of the factual issue I will have to address in due course:
“I also recognised that, as a consequence, there would be little benefit to Spassked, or IEL, if dividends were passed up to Spassked in a piecemeal manner. Accordingly, I expected that, over time, dividends would be passed up to GIH, and that at an appropriate point in time, the Board of GIH would declare one large dividend to Spassked.”
I expected that after a few years, Spassked’s debt to IEF would be repaid so that Spassked would cease to be a dividend trap. I cannot recall considering at the time of developing the Spassked Proposal precisely how this would be done. To the extent that I considered it, I recall thinking the most likely way Spassked would do this would be through the profits of GIH and its subsidiaries being used to fund a dividend, or that they would make some other distribution or payment to Spassked to enable it to retire the debt to IEF. The profits of GIH and its subsidiaries would be made from the businesses of those companies or from the sale of investments. I expected that the aggregate economic gains generated from the investments would be more than sufficient to extinguish the debts of Spassked to IEF at some point in the medium term.” (my emphasis)
Daniels discussed the proposal with Latham and Cottam. They were not directors of Spassked (Cottam was later appointed as a director of Spassked in 1998), but were Group Tax Managers. Cottam recalls that the Administration Team was told that Price had given his approval in December 1987. Daniels said that when he, Latham and Cottam formulated the proposal, and when he secured Price’s agreement to it and took steps to implement it, he expected:
· that GIH would use the funds obtained from Spassked to invest in Subcos;
· that the Subcos would own, or acquire, income producing assets or trading companies;
· that the Subcos would, in turn, pay dividends up to GIH as each of their investments matured;
· that the Subcos would, upon maturity of their investments, pay dividends up to GIH, to enable GIH to deliver a return to its shareholders, Spassked, and IEL;
· that Spassked would receive dividends from GIH once GIH’s investments in underlying Subcos began to mature and to produce a fund of profits from which dividends could be paid;
· that GIH would be in a position to pay dividends to Spassked;
· that once Spassked ceased to be a dividend trap, it would ultimately pass dividends up to IEL;
· that any proposed investment by Spassked in GIH would be assessed by Spassked’s directors’ taking “a portfolio approach”, that is, a decision based on a consideration of the Spassked/GIH sub-group as a whole;
· that, overall, profits within the Spassked/GIH sub-group would significantly exceed losses within that sub-group;
· that IEL would have a continuing obligation to pay dividends to its shareholders and to meet its operating expenses;
· that IEL would pay its shareholders franked dividends and would pay them unfranked dividends only in the event that it had insufficient franking credits to “fully frank” the dividends;
· that upon implementation of the Spassked proposal, GIH would become IEL’s principal source of franked dividends to meet the expectations of IEL’s shareholders, and that Spassked would eventually become IEL’s principal source of unfranked dividends, and further franked dividends, with which to meet the operating and other expenses of IEL, and to provide a fund of profits to pay dividends to IEL’s shareholders;
· that IEL would invest $150,000,000 in “B” shares of GIH, which would entitle IEL to franked dividends only, and a return of capital only, with no entitlement to participate in surplus profits on liquidation (Daniels said he understood that the $150,000,000 was based on the approximate present value of the stream of franked dividends expected to emanate from the portfolios of companies that would form part of the Spassked/GIH sub-group, and that this figure approximated the amount of franked dividends expected to be required by IEL’s shareholders);
· that Spassked, having received franked and unfranked dividends from GIH, would pay to IEL both franked and unfranked dividends;
· that Spassked would receive “the major proportion of the initial dividends from GIH” because the profits of the Subcos “would be grouped against the losses of IEL subsidiaries, of which Spassked would form the dominant part”, so that “the profits would be unfranked, at least to the extent of these losses”.
Daniels stated that:
“To the extent that the profits of the subsidiaries exceeded available losses, such profits would be subject to tax and would therefore carry imputation credits. Although IEL might be theoretically entitled to these profits under the Spassked Proposal, my intention in implementing the Proposal was that the majority of these dividends would flow to Spassked as dividends from GIH. It was my expectation that there would be an equitable distribution of these dividends, based upon the quantum of capital subscribed for. (my emphasis)
Over the three years 1988 to 1990 Spassked subscribed for $3,457,142,866 worth of “A” shares in GIH and IEL subscribed for $150,000,000 worth of “B” shares in GIH, and over the seven years 1988 to 1994, Spassked received unfranked dividends totalling $43,962,139 and IEL received franked dividends of $33,378,828. Clearly, if Daniels’ expectation was indeed “that there would be an equitable distribution of ... dividends”, that expectation was not fulfilled as events transpired.
Daniels said he further expected:
· that the future investment activities of the Spassked/GIH sub-group would yield a commercial return greater than the borrowing costs incurred by Spassked, this expectation being based on the quality of investments which Daniels expected the Subcos to make and the “investment track record” of the IEL Group over the many years of his employment;
· that reasonable returns on the Spassked/GIH sub-group’s investments, significantly in excess of its costs and expenses, would materialise;
· that the interest expense incurred by Spassked would “essentially match the interest income derived by those GIH subsidiary shelf companies, which placed their funds on deposit with IEF at interest, while awaiting suitable investment opportunities to present themselves”;
· that once the Subcos recalled their deposits with IEF to fund investments by the Subcos, the interest income previously earned by them would be replaced by the income they would earn on the assets they acquired;
· that “the interest deductions of Spassked would then be grouped against the income derived by the IEL group companies, including [the Subcos], in accordance with the grouping provisions in [the Act]”;
· that IEF would return the income derived on its interest bearing loans to Spassked as assessable income and that the Spassked Structure would not “give rise to any material tax advantages”.
In the course of the cross-examination of Cottam, the question of the method by which Spassked’s debt to IEF would be discharged was explored. Like Daniels, Cottam suggested that the funds necessary to discharge the debt would not be paid by GIH to Spassked in a piecemeal manner. Instead, he said the Subcos would pass funds up to GIH, either by way of dividend or return of capital, and the funds gathered in GIH would then be declared by way of dividend up to Spassked. The following exchange occurred:
“What you are saying, is this right, that as each of [the] subcos within the Spassked structure would realise its investment and be in a position to return capital back up to GIH and also dividend[s] perhaps retained or perhaps just for the current year. The position would be that GIH would not declare the dividend into Spassked until all of the investments had been realised and all of the capital had been marshalled so that the entire capital could be returned to Spassked and it could retire IEF’s debt – That is the perfect situation, yes.”
The declaration of a dividend by GIH to Spassked raised the question of whether the payment of that dividend would necessarily be a payment into a dividend trap; an event that both Daniels and Cottam had said would be avoided. Cottam suggested the Group could avoid trapping in Spassked any dividend paid to it by GIH if that dividend were paid so as to enable Spassked to discharge its debt to IEF (capital borrowed and the capitalised interest of previous years) early in the financial year. The idea is that by discharging the debt early in the year, Spassked would be able to forestall the accrual of any interest for that year and thus ensure that dividends were able to flow freely through it to IEL. The following exchange occurred during the course of cross-examination:
“So what you’re saying is that the dividend from GIH to Spassked early in the financial year could be used to finish off discharging the debt owed by Spassked to IEF? – That’s correct, yes.
And prevent interest expense running in that year? – That’s correct.
And as long as that were done then Spassked would not trap the dividend? – Yes.
And there would be no loss of rebate? – Yes. That’s just one way it could be done.
That’s just one way of doing it? – Yes.”
Cottam said he had no recollection of discussions in the latter half of 1987 about ways of unwinding the Spassked Structure, but said he recalled discussions about the necessity that a dividend ultimately be paid to Spassked if its directors were to “discharge their fiduciary duties to the company”. I do not accept this evidence of generalised discussion with unidentified persons about this issue as evidence that an expectation of receiving dividends from GIH was the occasion of Spassked’s borrowing from IEF.
Cottam said the two dividends were paid by GIH to Spassked because dividends were being paid by GIH to IEL at the same time. That is to say, someone suggested at that time that since a dividend was in the course of being paid to IEL, one should also be paid to Spassked. If so, this hardly suggests that payment of dividends to Spassked was part of the original plan back in late 1987, or from then down to 1990. Cottam’s evidence in the present respect was generally unsatisfactory. He could not recall any of the directors of Spassked (or of GIH – the same persons) stating that Spassked should be seen to be receiving a return on its investment in GIH. The following relevant exchanges occurred in Cottam’s cross-examination:
“Do you recall in any discussion of its being appropriate to declare a dividend to Spassked at the same time as declaring one to IEL of why that was so? – Just because cosmetically it looked, you know, well, not looked, it was IEL got a dividend so Spassked should get something for its investment, small as it may be.
But when you say cosmetically, for appearances to whom? – Well, for the directors of Spassked so they could say they got something back on their investment.
They were pretty much the same people as the directors of GIH weren’t they, in those two years? [the years ended 30 June 1990 and 30 June 1992] – I would have thought so.
There would at least have been a majority overlap in the boards, wouldn’t there? – I think that is the case but I can’t say for certain.
Since there were common directors on both sides, why did Spassked need to be able to say that they got something back for their investment, to whom? – Because they hadn’t – for the directors they hadn’t received anything from their investment if a dividend hadn’t been paid.” (my emphasis)
GIH in fact paid the following dividends to IEL and Spassked:
Year ended
Date franked dividend paid to IEL
Amount of franked dividend paid
to IELDate unfranked dividend paid to Spassked Amount of unfranked dividend to Spassked 30.6.88
29.6.88
$4,800,000
Nil
30.6.89 1.7.88
30.6.891,777,725
12,987,325Nil
30.6.90 14.6.90
14.6.903,558,000
10,023,70030.6.90 29,308,093
30.6.91 Nil Nil
30.6.92 1.10.91 49,999 8.10.91 14,654,046
30.6.93 1.7.92 182,079 Nil
30.6.94 Nil Nil
TOTALS
$33,378,828
$43,962,139
(Daniels’ affidavit states that the dividend of $182,079 paid to IEL is shown in GIH’s statutory accounts as having been paid on 30 June 1990.)
These figures make it difficult to accept that the two dividends were paid to Spassked because of a concern to give an appearance of equitable treatment of GIH’s two shareholders. The amounts of their investments in GIH were so disparate that equitable treatment would require that Spassked receive much more than the two amounts totalling $43,962,139 which it was paid.
I do not accept that it was part of the plan, purpose or expectation (in the sense explained) of the Spassked Structure that GIH would pay dividends to Spassked. I am prepared to accept that whatever the precise reasons for payment of the two dividends were, they arose spontaneously at the time and may, indeed, have been an attempt to create an appearance.
Summary
Clearly there may be a subjective expectation or purpose which is not well founded and is ill-considered and even irrational. But in the present case, I am simply not persuaded that there was, in the latter half of 1987, or at any time from then down to 28 June 1990, a motivation, subjective purpose or subjective expectation (in the sense explained earlier) that GIH would ever pay dividends to Spassked. I find that neither the directors of Spassked nor the IEL Group’s Administration Team discussed any means by which Spassked might ever receive dividends from GIH, because its doing so was not a part of their plan and was in fact inimical to it. There was no good reason why they should be thinking about destroying or reducing the utility of the Spassked Structure. I find that their hope was that it might remain in place indefinitely.
The most that I would be prepared to find is that Daniels, one of Spassked’s four directors and a member of the Group’s Administration Team, and Cottam, also one of the members of that Administration Team, thought that it may prove to be necessary one day, because of legal constraints relating to either the fiduciary duty of Spassked’s directors or the tax deductibility of the interest paid by Spassked, for some means to be found for Spassked to receive dividends from GIH, and if it did, this may be able to be achieved by resorting to the funds of GIH to discharge Spassked’s indebtedness to IEF. This falls far short of signifying that the occasion of the incurring of the interest expenses was an expectation of receipt of dividends or that Spassked incurred the interest expenses in carrying on a business for the purpose of receiving dividends from GIH.
I accept that the question of the long term future of the Spassked Structure may have fleetingly crossed the minds of Daniels and Cottam. But that was as far as it went. I find that what was important to them was to achieve the immediate objectives of making Spassked the dedicated dividend trap and loss centre of the Group: attention could be given to any unwelcome necessity which might exist for it to receive dividends from GIH in the future if and when the occasion to think about that unpleasant matter arose.
I do not accept that Daniels or Cottam expected (now in the neutral factual sense) that Spassked would receive, or was likely to receive, dividends from GIH. In so far as their testimony is to the contrary, I think they have engaged in a process of reconstruction of their 1987 thought processes. (It should go without saying that this does not suggest fabrication.) Having regard to the disparity between the large and rapidly increasing indebtedness of Spassked to IEF on and from 30 December 1987 down to 28 June 1990, and the level of GIH’s funds available to be paid to Spassked at any time during that period, and the lack of alarm or protest over that disparity at the time, I conclude that they saw nothing untoward in that growing disparity. Their acquiescence points against a subjective expectation or purpose that GIH’s funds were to be used to discharge Spassked’s debt to IEF.
I am not persuaded that Daniels or Cottam assessed or thought of the Spassked Structure as having a likely lifespan of five to ten years. I find that either they did not direct their minds to its lifespan at all, or that if they did, it was regarded as of no significance whatever and as something which may or may not call for attention at some unidentified future time. I think they arrived at the “five to ten years” estimate in the witness box or at least while reflecting upon the case in relatively recent times, not back in 1987 when the Spassked Structure was devised.
The ATO’s claims and resulting disputation prove to be of no significance. I accept Daniels’ testimony that the potential tax liability might well have inhibited payment of dividends if such a payment had been otherwise contemplated. But it was not contemplated: GIH was already committed to a course of not paying dividends to Spassked. It is not to the point to say that if Spassked had ceased to be a dividend trap and if it had ceased to have tax losses, nonetheless dividends would not have been paid to it for a new supervening reason: the possible tax liability. The character of the interest expense must be determined as at the time of its incurrence, in this case at the times of the borrowings of the money on which it accrued. It is at those times that expectations and purposes are to be identified. The position might be different if the ATO had asserted the tax liability before the first occasion of decision as to whether GIH was to pay dividends to Spassked, or if, somehow, the Commissioner’s only reason for regarding the interest expenses as non-deductible was the non-payment of dividends to Spassked after the outbreak of hostilities between the Group and the ATO.
I have dealt at length above with the states of mind of Daniels and Cottam. It should be emphasized, however, as I said earlier, that on the basis of the objective facts alone, that is, leaving their states of mind out of account, I would have no difficulty in concluding that the interest expense is not shown to be within subs 51(1). My purpose in addressing the states of mind of Daniels and Cottam is to allow for the possibility that the expense is within the subsection after all, notwithstanding appearances. The relevance of Cottam’s state of mind is doubtful in any event because he was not a director of Spassked at the relevant times, and I have not been prepared to attribute Daniels’ state of mind to his co-directors.
For the above reasons, I do not think that the required expectation (in the positive sense explained at [164]-[166]) or purpose is established, even having regard to Daniels’ and Cottam’s testimony as to their subjective expectations and purposes.
Spassked’s interest expense of $888,165,526 paid to IEF in respect of the year of income ended 30 June 1992 was not a loss or outgoing incurred in gaining or producing assessable (dividend) income from GIH, or necessarily incurred in carrying on a business for the purpose of gaining or producing such income.
Part IVA issues
Because of the conclusion just expressed, I am not required to address the Part IVA issues.
conclusion
For the above reasons, the sum of $888,165,526 was not an allowable deduction and the purported losses founded upon its deductibility transferred by Spassked to SPL and IEL were not available to be so transferred.
In fact, in the year of income ended 30 June 1992 GIH paid Spassked a dividend of $14,654,046. The parties did not make submissions in relation to the apportionment of the outgoing of $888,165,526, but treated the issue of its deductibility as an “all or nothing” affair. If the issue of apportionment is to be addressed, the parties may do so as part of their written submissions referred to in the next paragraph.
I will direct the parties to bring in agreed short minutes of orders to be made disposing of all three proceedings, consistently with the above reasons, and if agreement is not reached, the short minutes of orders for which they will respectively contend, accompanied by written submissions in support.
I certify that the preceding two hundred and forty-nine (249) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Lindgren. Associate:
Dated: 14 February 2003
Counsel for the Applicant
in each proceeding:D H Bloom QC, A H Slater QC,
P M Fraser, J HmelnitskySolicitor for the Applicant
in each proceeding:Blake Dawson Waldron Counsel for the Respondent
in each proceeding:G J Davies QC, D J Fagan SC,
M A Painter, S H StewardSolicitor for the Respondent
in each proceeding:Australian Government Solicitor Dates of Hearing: 15, 16, 17, 18, 22, 23, 24, 29, 30 April,
8 May 2002Date last submission received: 17 June 2002 Date of Judgment: 14 February 2003 annexure “a”
annexure “b”
annexure “c”
Subsidiary Transfer or
AllotmentDate of allotment
or transferNumber of shares Par value per share Total Consideration Harbour Securities Pty Limited Allotment 30-Dec-87 25,000,000 1.00 25,000,000 Datwillow Pty Limited Allotment 18-Jan-88 50,000,000 1.00 $50,000,000 Datside Pty Limited Allotment 18-Jan-88 100,000,000 1.00 $100,000,000 Harbour Securities Pty Limited Allotment 18-Jan-88 225,000,000 1.00 $225,000,000 Kachuga Pty Limited Allotment 18-Jan-88 100,000,000 1.00 $100,000,000 Industrial Equity Acquisition (No. 31) Pty Limited Allotment 18-Jan-88 50,000,000 1.00 $50,000,000 Industrial Equity Acquisition (No. 32) Pty Limited Allotment 18-Jan-88 75,000,000 1.00 $75,000,000 Stringdale Pty Limited Allotment 18-Jan-88 25,000,000 1.00 $25,000,000 Stringcrest Pty Limited Allotment 18-Jan-88 25,000,000 1.00 $25,000,000 Stringbooth Pty Limited Allotment 18-Jan-88 75,000,000 1.00 $75,000,000 Industrial Equity Acquisition No. 21 Pty Limited Allotment 18-Jan-88 25,000,000 1.00 $25,000,000 Stringbrook Pty Limited Allotment 18-Jan-88 50,000,000 1.00 $50,000,000 Industrial Equity Acquisition (No. 37) Pty Limited Allotment 18-Jan-88 150,000,000 1.00 $150,000,000 Hargreave Securities Pty Limited Allotment 31-Mar-88 375,000,000 1.00 $375,000,000 National Self Service Pty Limited Allotment 1-Apr-88 100,000,000 2.00 $200,000,000 National Self Service Pty Limited Transfer 1-Apr-88 100,000 1.00 $341,758 National Self Service Stores Pty Limited Allotment 1-May-88 39,910,000 2.00 $79,820,000 Bureya Pty Limited Transfer 9-Nov-88 2 1.00 $2 National Supermarkets Pty Limited Transfer 22-Nov-88 5000 2.00 $9,826 Valeten Pty Limited Transfer 8-Feb-89 2 1.00 $2 Winter Management Limited Transfer 31-Mar-89 10,100,000 1.00 $7,351,681 Stringnil Pty Limited Allotment 19-Apr-89 100,000,000 1.00 $100,000,000 Industrial Equity Acquisition (No. 15) Pty Limited Transfer 1-May-89 2 1.00 $2 Ilimsk Pty Limited Transfer 1-May-89 2 1.00 $2
Argyle Securities Pty Limited Allotment 31-May-89 1,200,000 1.00 $1,200,000 Bendor Pty Limited
Allotment 31-May-89 2,650,000 2.00 $5,300,000 Bourke Motels Pty Limited Allotment 31-May-89 400,000,000 1.00 $400,000,000 Hops Tasmania Pty Limited Allotment 31-May-89 30,000,000 1.00 $30,000,000 Country Producers Selling (1972) Limited Allotment 31-May-89 11,500,000 1.00 $11,500,000 Crooks National (Holdings) Pty Limited Allotment 31-May-89 23,500,000 1.00 $23,500,000 Fund Investment Pty Limited Allotment 31-May-89 13,500,000 1.00 $13,500,000 Guerdon Pty Limited Allotment 31-May-89 12,300,000 1.00 $12,300,000 IEL (Tasmania) Pty Limited Allotment 31-May-89 1,000,000 2.00 $2,000,000 IPE Holdings Pty Limited Allotment 31-May-89 3,000,000 2.00 $6,000,000 K Stroud Pty Limited Allotment 31-May-89 90,000 2.00 $180,000 Manhelm Pty Limited Allotment 31-May-89 128,500,000 1.00 $128,500,000 National Wholesalers Pty Limited Allotment 31-May-89 5,742 2.00 $41,003,622 Olenek Pty Ltd Allotment 31-May-89 205,000,000 1.00 $205,000,000 IEL No. 1 Pty Limited Allotment 31-May-89 3,350,000 1.00 $3,350,000 Parramatta Indoor Bowling Centre Pty Limited Allotment 31-May-89 5,750,000 2.00 $11,500,000 Portfolio Services (Nominees) Pty Limited Allotment 31-May-89 49,400,000 1.00 $49,400,000 Portfolio Services (Nominees) Pty Limited Allotment 31-May-89 49,400,000 1.00 $49,400,000 Resources Holdings Pty Limited Allotment 31-May-89 63,000,000 1.00 $63,000,000 Stringtell Pty Limited Allotment 31-May-89 1,850,000 1.00 $1,850,000 Sordale Pty Limited Allotment 31-May-89 2,705 2.00 $3,497,565 Spurious Pty Limited Allotment 31-May-89 40,000,000 1.00 $40,000,000 Taleve Pty Limited Allotment 31-May-89 8,000,000 1.00 $8,000,000 Tehike Pty Limited Allotment 31-May-89 83,400,000 1.00 $83,400,000 Tehele Pty Limited Allotment 31-May-89 2,200,000 1.00 $2,200,000 Tehonu Pty Limited Allotment 31-May-89 16,200,000 1.00 $16,200,000 Tejasa Pty Limited Allotment 31-May-89 35,000,000 1.00 $35,000,000 Vajuna Pty Limited Allotment 31-May-89 2 1.00 $15,000,000 W B Breads Pty Limited Allotment 31-May-89 10,000 1.00 $10,000 Romola Pty Limited Allotment 31-May-89 15,000,000 1.00 $15,000,000 Maya Licensed Grocery Pty Limited Allotment 31-May-89 27,500,000 2.00 $55,000,000 Norman & Sons Pty Limited Allotment 31-May-89 1,000,000 2.00 $2,000,000 Tejigi Pty Limited Transfer 1-Jul-89 2 1.00 $2 Tehihi Pty Limited Transfer 1-Jul-89 2 1.00 $2 Tehoma Pty Limited Transfer 1-Jul-89 2 1.00 $2 Tehiyo Pty Limited Transfer 24-Aug-89 2 1.00 $2 Datwillow Pty Limited
Allotment 28-Sep-89 59,999,998 1.00 $59,999,998 GET Auctions Pty Limited Transfer 3-Nov-89 2 1.00 $2 Industrial Equity Acquisition (No. 15) Pty Limited Allotment 15-Mar-90 99,999,998 1.00 $99,999,998 Industrial Equity Acquisition No. 21 Pty Limited Allotment 19-Mar-90 145,000,000 1.00 $145,000,000 Industrial Equity Acquisition (No. 15) Pty Limited Allotment 28-Jun-90 155,000,000 1.00 $155,000,000
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