The Commissioner of Taxation of the Commonwealth of Australia v BHP Billiton Limited

[2010] HCATrans 320

[2010] HCATrans 320

IN THE HIGH COURT OF AUSTRALIA

Office of the Registry
  Melbourne  No M117 of 2010
  No M118 of 2010
  No M119 of 2010
  No M120 of 2010

B e t w e e n -

THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA

Appellant

and

BHP BILLITON LIMITED

Respondent

Office of the Registry
  Melbourne  No M121 of 2010
  No M123 of 2010

B e t w e e n -

THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA

Appellant

and

BHP BILLITON PETROLEUM (NORTH WEST SHELF) PTY LTD

Respondent

Office of the Registry
  Melbourne  No M122 of 2010

B e t w e e n -

THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA

Appellant

and

THE BROKEN HILL PROPRIETARY COMPANY PTY LTD

Respondent

Office of the Registry
  Melbourne  No M124 of 2010
  No M125 of 2010

B e t w e e n -

THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA

Appellant

and

BHP BILLITON MINERALS PTY LTD

Respondent

FRENCH CJ
GUMMOW J
HEYDON J
CRENNAN J
BELL J

TRANSCRIPT OF PROCEEDINGS

AT CANBERRA ON TUESDAY, 7 DECEMBER 2010, AT 2.16 PM

Copyright in the High Court of Australia

__________________

MR S.J. GAGELER, SC, Solicitor-General of the Commonwealth of Australia:   If the Court pleases, in each appeal I appear with MS H.M. SYMON, SC, MR M.T. FLYNN and MR L.W.L. ARMSTRONG for the appellant.  (instructed by Australian Government Solicitor)

MR D.H.BLOOM, QC:   Your Honour, in those matters MR J.W. DE WIJN, QC and I appear with MS L.A. HESPE and MS K.J. DEARDS for the respondents.  (instructed by Mallesons Stephen Jaques)

FRENCH CJ:   Yes, Mr Solicitor.

MR GAGELER:   Your Honours, despite the size of the appeal books and the amount at stake, this is a very short case.  In terms of legislation it is sufficiently extracted in the annexures to our submissions in‑chief.  Annexure A‑1 is Division 243 of the 1997 Act in the relevant form and annexure A‑2 contains a couple of definitions extracted from section 995‑1 of that Act.  I will refer to a couple of other provisions but your Honours need not look to anything other than Division 243 and those couple of definitions.

FRENCH CJ:   This Division was introduced in 2001, was it? 

MR GAGELER:   That is correct.

FRENCH CJ:   But it applies to debts terminated back to 1998.

MR GAGELER:   Yes.  The relevant Act introducing the division was the Taxation Laws Amendment Act(No 1) 2001 and the relevant backdating provision was in Item 109 of Part 5, Schedule 2. If I can go immediately to Division 243, section 243-10 contains what is described as a guide and within the 1997 Act there are some other provisions that tell you about a guide. Section 950.100 says that a guide forms “part” of the Act and Section 950.150 says that a guide can be considered in determining the object or purpose of an operative provision and in determining the meaning of an operative provision. The guide and other provisions within Division 243 refer to ‑ ‑ ‑

GUMMOW J:   I am sorry.  To what guide provision were you referring?

MR GAGELER:   Section 950.100 and section 950.150, a guide to a guide, your Honours.  Then the expression “capital allowance deductions” not within the definition extracts that were given, your Honours - the precise definition within section 995-1 varied from time to time during the course of the years with which the present proceedings are concerned, but “capital allowance deductions” as defined in section 995-1 include a range of deductions all in the nature of depreciation or amortisation of capital expenditure.  Those which were always there and relevant for present purposes were deductions under Division 40, Division 43 and section 73B of the Act.  Reading from the guide, if I may, it tells us:

This Division tells you –

“You” being the taxpayer debtor –

when you must include an additional amount in your assessable income at the termination of a limited recourse debt arrangement.  It also tells you what the additional amount is.

Basically, the Division applies where the capital allowance deductions that have been obtained for expenditure that is funded by the debt and the deductions are excessive having regard to the amount of the debt that was repaid.

The reason for the adjustment is to ensure that, where you –

the taxpayer debtor –

have not been fully at risk in relation to an amount of expenditure, you do not get a net deduction if you fail to pay that amount.

I should take your Honours to the provisions of the Act that deal with the consequence of the division applying.  They are contained within Subdivision B and Subdivision C.  Subdivision B, beginning with section 243-35, requires there to be a working out of the excessive deductions, and the excessive deductions are given, if you leave all of the peripheral potential issues aside, by looking to subsection (1), subsection (2) and subsection (4), and what you are looking for in subsection (2), in essence, is capital allowance deductions that have already been made by the debtor during the course of the loan.  You only need to look to step 1 within subsection (2) to see that that is what it is about, and what you are looking at then in subsection (4) is the capital allowance deductions that would have been made if the original expenditure giving rise to those deductions had been reduced by what turns out to be the unpaid amount of the debt.

Again, leaving peripheral things aside, if you read the chapeau of subsection (4) and the chapeau in the first sentence of paragraph (1) within the box, that is what it tells you.  So you are looking at the difference between the capital allowance deductions actually made and the capital allowance deductions that would have been made if the debtor’s original capital expenditure had been reduced by the amount that the debtor, in the events that have occurred, does not actually have to pay, that is, we are told by subsection (1), the excessive deductions.

Then you go to see what you do with that working in Subdivision C and section 243-40 tells you that the debtor’s assessable income for the income year in which the termination of the debt occurs is to include the excess referred to in section 243-35(1), that is, in the year of the termination of the debt you claw back the deductions to the extent that they are shown by the advents of termination to be excessive.

Then section 243-55, requires the making of corresponding adjustments to capital allowance deductions in subsequent years.  So you claw back the extent to which the deductions are shown to have been excessive in the past and in the year of termination and for the future you make a corresponding reduction in the capital allowance deductions by reference to the amount of the debt that was not repaid. 

Now, the reason for doing all that, going back to the guide, we are told in the third paragraph, is to ensure that where you, the taxpayer debtor, have not been fully at risk in relation to an amount of expenditure you do not get a net deduction if you fail to pay that amount.  That reason or rationale or legislative statement of policy is one that obviously informs the construction of the provision in issue in the present case.

In our submission, the notion that is there expressed of being, or not being as the case may be, fully at risk is one which is inherently factual, practical and commercial in its content.  If you go to section 243 ‑ ‑ ‑

CRENNAN J:   Does it mean when you have not been fully at risk throughout the whole period of the debt?

MR GAGELER:   Yes, your Honour, from the inception of the debt and there is no difference between us about that.  Section 243‑15(1) then says:

This Division applies if:

(a)      limited recourse debt has been used –

The grammar is not perfect –

to wholly or partly finance or refinance expenditure; and

(b)      and at the time that the debt arrangement is terminated –

The word “terminated” your Honours might note is defined in section 243‑25 relevantly in paragraph (g) to include a debt becoming “a bad debt”, that is simply being written off by the creditor, so –

the debt has not been paid in full by the debtor; and

(c)the debtor can deduct an amount as a capital allowance . . . for the income year in which the termination occurs, or has deducted or can deduct an amount for an earlier income year, in respect of the expenditure for the financed property.

Now, there is no dispute in the present case that if paragraph (a) applies, paragraphs (b) and (c) apply also.  Before I go to the definition of “limited recourse debt”, can I draw your Honours’ attention to the definition of “financed property” in section 243‑30.  Subsection (1) says that:

Property is the financed property if the expenditure referred to in paragraph 243‑15(1)(a) is on the property, is on the acquisition of the property, results in the creation of the property or is otherwise connected with the property -

a very broad definition to which her Honour at first instance drew attention.  Then subsection (3) paragraph (a) of the same section, section 243‑30, says that if you have financed property then that financed property is also “debt property” for the purposes of these provisions.  So section 243‑20 then defines “limited recourse debt”.  Subsection (1) is uncontroversial.  It says:

A limited recourse debt is an obligation imposed by law on an entity (the debtor) to pay an amount to another entity (the creditor) where the rights of the creditor as against the debtor in the event of default in payment of the debt or of interest are limited wholly or predominantly to any or all of the following –

We need not go past paragraph (a) ‑ ‑ ‑

FRENCH CJ:   It is common ground that in subsection (1) the reference is to legal rights, legal limitations?

MR GAGELER:   Absolutely.  What is common ground about subsection (1) which was not common ground below is that subsection (1) looks to the time of the obligation being imposed on the debtor, that is, if you like, when the loan is entered into and it speaks of the legal rights of the creditor and it speaks of legal limitations on those legal rights.  Its application is potentially modified in particular circumstances by subsection (5) and subsection (6) and your Honours will see that subsection (6) brings in broader practical considerations and, in our submission, also has a broader temporal application, that is they are not confined to looking simply at the time that the obligation of the debtor arises.  Subsection (5) says:

an obligation that is covered by subsection (1) is not a limited recourse debt if the creditor’s recourse is not in practice limited due to the creditor’s rights in respect of a mortgage or other security over property of the debtor (other than the financed property) the value of which exceeds, or is likely to exceed, the amount of the debt.

Then subsection (6) says:

Also, an obligation that is covered by subsection (1), (2) or (3) is not a limited recourse debt if, having regard to all relevant circumstances, it would be unreasonable for the obligation to be treated as limited recourse debt –

with the consequences that flow under the provisions we have just looked at.  Subsection (2) is what Justice Hayne, if he were here, would call the killing ground.  Let me read it and then attempt to unpack it.  It says:

An obligation imposed by law on an entity (the debtor) to pay an amount to another entity (the creditor) is also a limited recourse debt if it is reasonable to conclude that the rights of the creditor as against the debtor in the event of default in payment of the debt or of interest are capable of being limited in the way mentioned in subsection (1).  In reaching this conclusion, have regard to:

(a)the assets of the debtor . . . 

(b)any arrangement to which the debtor is a party –

the word “arrangement” being defined to mean:

any arrangement, agreement, understanding, promise or undertaking, whether express or implied, and whether or not enforceable (or intended to be enforceable) by legal proceedings. 

That is the definition in 995‑1.

(c)whether all of the assets of the debtor would be available for the purpose of the discharge of the debt . . . 

(d)whether the debtor and creditor are dealing at arm’s length in relation to the debt.

“Arm’s length” being informed, although not technically defined by what appears in section 995‑1 in the extract that we have given your Honours, “arm’s length” it is said:

in determining whether parties deal at arm’s length, consider any connection between them and any other relevant circumstance.

It is common ground that subsection (2) like subsection (1) looks to the time the obligation is imposed on the debtor and it is common ground that when subsection (2) speaks of the rights of the creditor being limited in the way mentioned in subsection (1), it is speaking of legal limitations on the creditor’s legal rights in the event of default by the debtor.  From reading our learned friend’s written submissions, it is also common ground that subsection (2) poses a factual question and the question is, what is that factual question?  Can I unpack a couple of elements of it and then state what we say the factual question is.

The element that says it is reasonable to conclude, in our submission, requires an objective factual conclusion that is available to a reasonable person.  The language is very close to the language of section 177D(b), but it is a bit different, and your Honours will recall section 177D(b), in the context of Part IVA, asked whether it would be concluded, and here the question is a little broader.  It is whether it is reasonable to conclude – the question, in our submission, asking really whether the conclusion that is posited by the subsection falls within a range of reasonable conclusions, given the factual scenario.  The word “capable”, in our submission, in the context in which it appears, means nothing more or less than the ordinary dictionary definition, or one of them, susceptible.  “Capable of” equals, in our submission, susceptible to and ‑ ‑ ‑

FRENCH CJ:   It must mean something more, must it not, than that which reflects the capability, or the capacity of any creditor and any debtor to vary their arrangements.

MR GAGELER:   Absolutely, your Honour.  That must be so, otherwise, at a theoretical level – as we have said in our submissions in reply – at a theoretical level, in any arm’s length transaction it will always be theoretically possible, conceivable, that the debtor and the creditor would choose to vary their contractual arrangements.  But what is in it for the creditor in such a case?  It is nothing more than a theoretical possibility, and that one is concerned here with more than “theoretically capable” is really necessitated, not only by the purpose that you get from section ‑ ‑ ‑

GUMMOW J:   The question is, perhaps, what engenders the susceptibility?

MR GAGELER:   You have regard to the factors in paragraphs (a) through to (d), so it is a practical or commercial susceptibility, having regard ‑ ‑ ‑

GUMMOW J:   But the susceptibility is engendered by (a), (b), (c) and (d), is it?

MR GAGELER:   That is right.  That is the structure of the section. 

CRENNAN J:   Why cannot one just say that, when you are looking at “capable”, what you are talking about is whether the rights are able to be ‑ ‑ ‑

MR GAGELER:   “Able” is ‑ ‑ ‑

CRENNAN J:   ‑ ‑ ‑ able to be limited.  So you can get out of questions of susceptibility ‑ ‑ ‑

MR GAGELER:   Your Honour, I am happy with that.  That is another of the dictionary definitions.

CRENNAN J:   I see.

MR GAGELER:   “Able” is a good way of putting it.  But “able” critically – I think this may be the only difference between us – “able”, in our submission, “capable”, “able”, “susceptible” encompasses the possibility of contractual variation.  That is our submission.  If I were to – and I am conscious that paraphrases are dangerous, and particularly paraphrases drawn from statements about other provisions in other legislation, but can I give your Honours two paraphrases which appear, at least by inference, in the submissions. 

One is in paragraph 32 of our submissions‑in‑chief.  We have drawn attention to a statement of Justice Webb where unpacking the word “capable” he said that it could mean “practically capable” or it could be confined to “legally capable”.  Of course, there is not an absolute dichotomy between those two concepts.  In our submission, what “capable” is meaning here is “practically capable”, “able”, “susceptible”, or to adopt the language of Justice Lockhart in the News Corporation Case, which we have noted in footnote 1 of our reply, and which was quoted and applied in a case called Canwest, which your Honours do have on the list of authorities, 82 FCR 46 at page 77, Justice Beaumont quoting Justice Lockhart at that page.

What the word “capable” is concerned with, in our submission, is practical and commercial considerations rather than highly refined legalistic texts.  That is Justice Lockhart’s language drawn from another context.  So, in our submission, the answer to the question, what is the factual question posed by subsection (2) is, the questions is, whether it is reasonable to conclude that the legal rights of the creditor, whatever they might be at the time the obligation to repay becomes imposed on the debtor, are able in a practical and commercial sense to become legally limited in the way mentioned in subsection (1).

GUMMOW J:   That is true of any contractual arrangement.

MR GAGELER:   At a theoretical level.  It is true of any contractual arrangement at a theoretical level.  That is why the question must be asked at more than a theoretical level and that is why the subsection requires regard to be had to the sort of circumstances where more than theory will come in to play. 

CRENNAN J:   Does paragraph 34 of the respondents’ submissions capture the difference between the two of you on this aspect of the case?

MR GAGELER:   Probably.  I do not know if your Honour has had an opportunity to read carefully our submissions in reply, but I gave a lot of attention to the respondents’ submissions over the weekend and I am not sure what is being said.

CRENNAN J:   Well, it is hinging on this notion of possibilities.

MR GAGELER:   All I can say in answer to your Honour’s direct question is possibly.

FRENCH CJ:   So the capability or susceptibility with which we are concerned is an attribute of the rights at the time they come into existence?  At the time the debt is created.

MR GAGELER:   It is not so much an attribute, it is ‑ ‑ ‑

FRENCH CJ:   A qualification upon?

MR GAGELER:   You could put it that way, yes.  It is an attribute of the circumstances in which the rights come into existence.

FRENCH CJ:   But it is not a legally effective attribute.  You would bring within the scope of this subsection, for example, a creditor/debtor arrangement accompanied by a letter of comfort which says that if things do not work out we will not claim more than the recovery of your security, even if that were not legally binding.

MR GAGELER:   Of course, and, to be fair to him, my learned friend would probably say that as well.  He would probably say that as well.  Of course he would have to accept – or no, he would not.  He might.  He might go close to saying it because he would probably be compelled by the definition of “arrangement” to get very close to conceding that.  Of course, that is just one possibility that is encompassed within paragraph (b) of the considerations that are to be taken into account. 

The other factors, paragraphs (a), (c) and (d) are all of a potentially much broader compass and take into account, in our submission, a broader practical or commercial reality.  Of course, it has to be recognised that the words “reasonable to conclude” would be pretty much redundant if the only conclusion to be reached was one of the precise legal rights of the parties existing at the time of the obligation to pay being imposed on the debtor.  The reasonableness of the conclusion would not seem to enter into it.  Rights are rights. 

CRENNAN J:   May I ask you a question just to see where we are going?  If you direct attention to paragraph 48 of your submissions and paragraph 50, in 48 there is the assertion that Finance:

from the inception of the DRI loans, would have complied with a request or direction from [the parent] to accept a contractual limitation on its recourse rights –

Then at the end of 50 there is a reference in the last three lines to the parent:

possessing the ability to limit Finance’s rights to recover ‑ ‑ ‑

MR GAGELER:   Yes.

HEYDON J:   But are we not crossing out 50 and 49?

MR GAGELER:   Yes to everything that has been put to me.

CRENNAN J:   Is that the possibility you are adverting to?

MR GAGELER:   Yes, that is correct.

GUMMOW J:   You have withdrawn 49 and 50, I think.

MR GAGELER:   Withdrawn 49 and 50.  Your Honours will see ‑ ‑ ‑

GUMMOW J:   But 48 is still there?

MR GAGELER:   Yes, 48 is still there.  Our learned friends objected to us relying on paragraph (b) and we do not feel the need to fight about things like that.  Your Honours, the policy reason for taking that approach ‑ ‑ ‑

GUMMOW J:   This really hinges upon some finding of fact.  Has that been made?

MR GAGELER:   No.  There has been no finding of fact.  If your Honours were inclined to remit it for a finding of fact, then your Honours might take that course, but neither side is asking for that.

CRENNAN J:   Was the trial judge asked to make a finding in relation to confining it to 48 to this idea that Finance would have complied with a request or direction from the parent?

MR GAGELER:   No, it is fair to say she was not.  It is fair to say that the arguments presented to her Honour and to the Full Court were fairly broad in their range.

CRENNAN J:   Well, you were dealing with a lot more than this particular issue.

MR GAGELER:   That is right.  The submissions become much pointier before your Honours and I cannot say that there was a request for a finding in those terms. 

GUMMOW J:   What was the proceeding before Justice Gordon?

MR GAGELER:   It was an appeal under section 14ZZ of the Taxation Administration Act, or a series of appeals under section 14ZZ of the Taxation Administration Act.

GUMMOW J:   But it had not gone through the AAT?

MR GAGELER:   No.  Your Honours, it will be our submission that the necessary factual conclusion, as one within a range of reasonable factual conclusions, is one that your Honours can comfortably draw.  Before I move on to the facts in the case, may I just say one further thing in support of the broad submission as to the construction of subsection (2) that we make, and that is, relating it back to the legislative policy that legitimately emerges from the structure of the provision and from the last sentence of the guide in section 243‑10 and that is this.  If a practical or commercial susceptibility, more than a theoretical susceptibility, exists at the time a loan is entered into of the rights of the creditor against the debtor being reduced in the event of default, then it cannot be said that the debtor is fully at risk when, during the course of the loan, the debtor makes capital allowance deductions.

The policy spelled out in the guide is that a debtor ought not, in those circumstances, be allowed to retain a benefit of a capital allowance deduction if and to the extent that the debtor, in fact, ends up not having to pay.  That is the only circumstance in which these provisions cut in, that is where the debt arrangement is terminated and the debt has not been paid in full by the debtor but the debtor has in the past claimed and been given capital allowance deductions.

An ameliorating factor in what might be seen to be an otherwise potentially very wide operation of subsection (2) lies in subsection (6) because section 243-20(6) will disapply subsection (2) where:

having regard to all relevant circumstances, it would be unreasonable for the obligation to be treated as limited recourse debt.

GUMMOW J:   Would a relevant circumstance be an external source of credit funds?

MR GAGELER:   It may well be, yes.

GUMMOW J:   Is there evidence of that?

MR GAGELER:   In the present case?

GUMMOW J:   Yes.  What was the source of funds for BHP to make this expenditure in such large amounts?

MR GAGELER:   There were two sources of funds.  There were ‑ ‑ ‑

GUMMOW J:   Using BHP in a global sense for the moment.

MR GAGELER:   Yes.  There were capital injections from BHP entities and there was the loan from Finance.

FRENCH CJ:   Finance got its funding, in part, from external sources.

GUMMOW J:   I am talking about third parties external ‑ ‑ ‑

MR GAGELER:   I am sorry, third parties?

GUMMOW J:   External sources outside the BHP bailiwick.

CRENNAN J:   Finance borrowed from external parties to ‑ ‑ ‑

MR GAGELER:   Finance borrowed from external lenders and a whole range of them and so far as the capital injections are concerned the precise source of funds is not identified in the evidence.

GUMMOW J:   Is there evidence as to the nature of those arrangements with the external finance sources?

MR GAGELER:   Yes.

FRENCH CJ:   There is a list of borrowings from external sources somewhere, is there not?

MR GAGELER:   That is right.  But it is no part of my case to bring those into subsection (6), your Honour.

GUMMOW J:   It might not be part of your case.

MR GAGELER:   I should say my learned friend does not rely on subsection (6).  I am mentioning it as a ‑ ‑ ‑

CRENNAN J:   But presumably Finance was subject to all sorts of the usual arrangements in relation to those loans from ‑ ‑ ‑

MR GAGELER:   From external sources?

CRENNAN J:   ‑ ‑ ‑ from external sources.

MR GAGELER:   Yes, at one stage your Honours will have seen in ‑ ‑ ‑

CRENNAN J:   Including all sorts of covenants about their own position.

MR GAGELER:   At one stage ‑ ‑ ‑

GUMMOW J:   And the need for approval ‑ ‑ ‑

MR GAGELER:   From lender ‑ ‑ ‑

GUMMOW J:   ‑ ‑ ‑ by the external source for machinations in‑house.

MR GAGELER:   At one stage a loan made by Finance to DRI put Finance in breach, or at least potentially in breach of some covenants to external lenders and that resulted in a capital injection from another BHP entity.  Your Honours will have seen that.

Now, if I am correct about the construction of the subsection, then I need to make the case good on the facts and, in our submission, that should be relatively straightforward.  The relevant loan from Finance to DRI, that is, the loan that was in existence at the time of termination on 3 May 2000 when the debt was written off by Financers as “bad”, was that found by the trial judge at paragraph 157 in volume 8 of the appeal book.  That is at page 3315.

FRENCH CJ:   These loans were governed by standard form terms developed for intra‑company loans in the BHP Group?

MR GAGELER:   That is right.  Her Honour sets out those standard terms at paragraph 21 of the judgment.  They were standard terms that had been set by a resolution of the Finance board on 30 November 1994 and what they provided for was, relevantly in paragraphs (b) and (h), a term of five months with the possibility of renewal at the end, and what happened in practice your Honours will see from paragraphs 33 and 34, which your Honours might note I have drawn from the evidence of a Mr Ahyick ‑ ‑ ‑

FRENCH CJ:   Paragraph 33 reflects some common ground, I think, does it not?

MR GAGELER:   Yes, paragraphs 33 and 34.  So what happened was that following an investment decision by BHPB, you find the implementation of that investment decision so far as there is seen to be a requirement for debt funding of an operating company by Finance providing that funding pursuant to these standard terms of conditions with the loan being rolled over, interest being capitalised at the end of every five months.  The way that was done in practice was that Finance kept for each loan two accounts and at the end of five months the loan would be terminated in one account and ‑ ‑ ‑

CRENNAN J:   Rolled over into the other account?

MR GAGELER:   Rolled over into the other account.  The consequence, for present purposes for the starting point for subsection (2) is, if you are looking at the obligations of DRI and the rights of Finance as at the time DRI comes to be obliged to repay the loan that is terminated, you are looking at the rollover that occurred on the 30 November 1999 and that is the finding of fact about the novation of the contract at that time that her Honour makes at paragraph 157.  So it builds on what she says at paragraphs 21, 33, and 34.  She analyses that legally, in our submission, wholly correctly in paragraphs 154 ‑ ‑ ‑

FRENCH CJ:   That was all relevant also to her treatment of the interest?

MR GAGELER:   That is right.

FRENCH CJ:   Because they were capitalised.

MR GAGELER:   That is the context in which she is making these findings, but relevantly for present purposes, that is the loan with which we are concerned and the time with which we are concerned –30 November 1999.  A loan of, your Honours see, just over two billion dollars made on those standard terms and conditions set out at paragraph 21.  It is that loan which in terms of section 243-15(1)(a) refinanced the expenditure that DRI had been making for some years before on and in relation to the HBI plant.  That was expenditure that the trial judge accepted to be on debt property.  When I say “accepted”, she dealt with it on an onus of proof.  Your Honours look at that in paragraph 220, page 3336, at about line 50 where she says:

However, if I am wrong in my conclusion about the nature of the Finance/BHPDRI loan facility not being limited recourse debt, in my view the taxpayers have failed to establish that the property on which the funding was expended was not “debt property”.  Put another way, the taxpayers failed to identify the source of funding to acquire the property.

That needs to be read with a slightly fuller explanation which I will not read that her Honour gives at paragraph 223, particularly at about line 30.  If you look, as we say you should, in applying subsection (2) of section 243‑20 to the circumstances of the loan as at 30 May 1999, the question is, was it reasonable to conclude that the rights set out in Finance’s standard terms and conditions – paragraph 21 of her Honour’s judgment – were in practical or commercial terms capable, able, susceptible of being varied so as to limit the legal rights of Finance in the event of default by DRI wholly or substantially to rights in relation to the HBI plant?  That is the question.  In our submission, a positive answer, yes, it is reasonable to conclude that, flows really from a combination of two things. 

One is the asset position of DRI at that time, that is, the paragraph (a) and paragraph (c) factors considered together, and the other is the structure and practice of the BHP Group of companies and the circumstances in which that book entry, which is all it was, on 30 May 1999 occurred, that is, the paragraph (d) factor, in combination with the absence of a paragraph (b) factor, that is, the absence of anything in the relationship of the parties in the nature of a parent company guarantee, in the nature of an indemnity and the nature of a letter of comfort or something that might have suggested that such a variation was in the circumstances to be treated as nothing more than theoretical.

Your Honours, so far as the asset position of DRI is concerned, it is somewhat surprising to see an issue taken about that in our learned friend’s submissions, but may I deal with it briefly.  The asset position, in our submission, as emerges very clearly from the evidence, is that as at 30 November 1999 the only substantial asset of DRI was the HBI plant and associated facilities, and you see that from two sources.  You see it first from the terms of the review, that is a commercial review that her Honour refers to in paragraph 49 of her reasons, which he refers to having occurred in March and having been completed in April, combined with what then actually occurred, as she records in paragraph 57, second sentence:

On 31 May 2000, BHPDRI wrote off the balance of its HBI investment –

in that sum.  The actual review, your Honours, will find in volume 4 of the appeal book and I will take your Honours to a couple of pages in volume 4 and a couple of other pages in volume 8 and to nothing else in the eight volumes.  Volume 4 of the appeal book at page 1778 is a document described in an affidavit - your Honours need not turn back to this but your Honours might note it is described in the affidavit of Mr Hall, page 1674 at paragraph 29 and it is the document – it is the review that her Honour is referring to.  It is headed “Review of Carrying Value – Port Hedland HBI Plant”.  If you go to page 1780, line 30:

It is recommended the carrying value of the Port Hedland HBI plant be written off at 31 March 2000.  The amount to be written off is $1,138 million before tax ($794 million after tax).

That was the amount your Honours have seen ended up being written off. 

This is based on the net assets at 31 March 2000 of $1,148 million less working capital items of $5 million and land of $5 million.

As your Honours see, that recommendation, that is the write‑off of $794 million after tax, was implemented.  If you go to the annual report of DRI for the year ended 31 March 2000, which is in volume 8 at page 3157, your Honours see the “Directors’ report”.  This is for the year ended 30 June 2000.  At 3158 line 30, it is said:

The principal activities of the Company during the period was the operation of a hot briquetted iron plant and associated facilities at Port Hedland, Western Australia. 

There is then a heading about line 35, “Review of Operations”:

The plant has encountered production difficulties in its first full year of operation.  Technical process problems during the processing of iron ore fines has caused blockages and restricted production.  Following the difficulties in production and estimated lower long term production capacity the carrying value analysis recommended a further writedown of the plant.

That is what we have just seen.  The actual writedown that occurred, you can then see at page 3161 at about line 20.  Your Honours will see the heading for “Non-Current assets” and you will see the 31 May 1999 value, the 30 June 2000 value for property, plant and equipment.  Your Honours will see the relatively modest amount for “Other”.

If you go to page 3171, without spelling out everything that is to be drawn from note 10 and from note 11 that appear on that page, what they show is that when you take away the value of the HBI plant of over $1 million, previously valued at over $1 million, what ‑ ‑ ‑

FRENCH CJ:   What are we feeding this into?  Is it (a) or (c)?

MR GAGELER:   We are feeding it into (a) and (c), that is ‑ ‑ ‑

FRENCH CJ:   Yes.  At what time?

MR GAGELER:   This is five months after the date of the ‑ ‑ ‑

FRENCH CJ:   Of the last rollover?

MR GAGELER:   ‑ ‑ ‑ of the last rollover to be inferred that at the time of the last rollover the substantial assets of the debtor DRI were pretty much limited to the HBI plant which was refinanced by the loan.  You take that away, you have got about $4 million worth of land and buildings and you have got a future tax benefit of about 169 million and that is it.

BELL J:   Justice Gordon was reluctant to make a finding of that character.  At paragraph 218 she refers to a list of the DRI property that had been tendered in evidence and then the finding is that it is by no means clear that all of that property was located at the plant.

MR GAGELER:   That was before she went on to make that further finding that I have already referred your Honour to before she went on to determine this relevant point about debt property against our learned friends on an onus of proof.  What her Honour actually says at that page, if I can turn it up and deal with it ‑ ‑ ‑

BELL J:   I just wondered what it was a reference to.  You have taken us to some evidence and it was not ‑ ‑ ‑

MR GAGELER:   Yes.  What I have taken your Honours to is really the strongest evidence on this point, that is, you take away the HBI plant and you have got virtually nothing left, or certainly nothing substantial left.  What her Honour was there referring to, in our submission, in the sentence that you have drawn my attention to in paragraph 218, was the list of property that BHPDRI tendered in evidence which she noted included licences and intellectual property.  It may well be that her Honour was just not sure what value should be attached to those licences and intellectual property and that seems to be the reason for that doubt.  If the doubt is not cleared up by what I have just taken your Honours to, I think the doubt should be cleared up when regard is had to the Ernst & Young report of 3 May 2000, which is a report her Honour referred to in paragraph 55 of her reasons.  That appears at volume 4, page 1278.

FRENCH CJ:   This gave a sort of a binary ‑ ‑ ‑

MR GAGELER:   I am sorry, page 1728.  For a case about numbers I am not doing too well with digits, your Honour.

FRENCH CJ:   This gave a kind of binary outcome, did it not?  It is either 300‑odd million or nothing?

MR GAGELER:   Yes, that is right.  In that report, which begins at page 1728, at page 1757 Ernst & Young helpfully list what they saw at that time as the value of assets, the source of which you can see from the bottom of the table at page 1757 is the HBI asset register, and what they say at page 1758 about line 48 is that:

A close down scenario is expected to result in a negligible value for fixed assets due to:  the unique nature of the asset; agreements with the West Australian government (the “State Agreements”); and the costs associated with dismantling and recovering the particular assets.

So, so far as it might be thought that there was some value to be ‑ ‑ ‑

GUMMOW J:   What are the State agreements?  They may be a relevant circumstance too.

MR GAGELER:   Yes.

GUMMOW J:   Is there evidence of them?

MR GAGELER:   Yes, yes there is. 

GUMMOW J:   Anyhow, that can be turned up at some stage.

MR GAGELER:   Yes, I would need to turn it up, your Honour.

GUMMOW J:   I need to ask you this, too.  At paragraph 220 of her reasons, the primary judge, naturally enough, refers to section 14ZZO of the Administration Act and Dalco.  To what extent, in working through these criteria in 243 that you are taking us to are questions of onus involved?  Is there a shifting onus or just the ordinary onus?

MR GAGELER:   It is just the ordinary onus which casts the onus on the taxpayer in relation to the entire factual inquiry. 

GUMMOW J:   It is an unusual inquiry - that is the trouble - because of the way 243 is cast.

MR GAGELER:   It is an unusual inquiry but it has a purpose.  It has quite a clear policy purpose.  It is an inquiry that you engage in, in circumstances where a debtor, the subject of the inquiry ultimately, has had the benefit of previous capital allowance deductions and now does not have to repay the debt and, if its wide operation and reverse onus of proof in particular circumstances produce what seems to be an unreasonable result, then that is dealt with by subsection (6). 

GUMMOW J:   Just say that again.  If applying questions of onus ‑ ‑ ‑

MR GAGELER:   Yes.  If the broad nature of the inquiry which is mandated by the subsection (2) combined ‑ ‑ ‑

GUMMOW J:   Well, the broad nature of that which has to be disproved by the taxpayer.

MR GAGELER:   That is right - appears in circumstances of a particular case – that is, the conclusion that is reached in circumstances of a particular case – appears to be an unduly harsh result not in accordance with the policy of Division 243, then that is to be dealt with by reference to the reasonableness test in subsection (6), that is, subsection (2) can be disapplied where the application of the division would be an unreasonable result in particular circumstances.

FRENCH CJ:   Does the taxpayer have to show that, in the language of 243(2), it is not reasonable to conclude, or is it sufficient that the taxpayer show that on all the material there is insufficient to reasonably conclude.  It may be that the two things collapse into each other.

MR GAGELER:   If there is a difference between the two, we would prefer the former, your Honour.  There may be no difference between the two, but the former is a clearer articulation which we would adopt, yes.

FRENCH CJ:   Incidentally, in relation to the Ernest & Young review and questions of timing, the asset stayed in position and effectively kept operating – I use that term loosely – for about five years, did it not, after the writedown?  Is that the timeframe?

MR GAGELER:   That is about right.  In 2004, I think.  In 2005 it ceased operations, yes.  Your Honours, if then we are correct in saying that either the better conclusion to be drawn from the evidence is or that our learned friends have not disproved that as at 30 May 1999 the assets of Finance were predominantly the HBI plant and associated facilities, the debt property, then the point of that in terms of paragraphs (a) and (c) is that by agreeing to a contractual variation of its rights in the event of default so as to be limited predominantly to the HBI plant and associated facilities, Finance would be giving up little or nothing of value.  The other factor that I point to, and that is the paragraph (d) factor, comes down to this.  Her Honour at paragraph 108 said this, at about line 50 on page 3299:

Each investment was considered by the BHPB board in accordance with usual practice . . . and once approved by the BHPB board, the funding of that investment was determined in accordance with BHPB’s Accounting Policy Manual –

which she set out relevantly at paragraph 19 and without reading the entire extract, which is all that is relevant from the accounting policy manual that appears at paragraph 19, the gist of it is that once an investment decision was made by the BHPB board, its implementation by companies within the BHPB group, relevantly here Finance, DRI and the other company within the group that provided capital injection into DRI, was worked out, as you would expect, by the accountants and the lawyers for the group, and it was kept under continuous review.

You see an example of that continuous review referred to by her Honour at paragraph 31 – I am sorry, that is the initial implementation at paragraph 31 – where in the quotation from the memorandum that her Honour has extracted, a memorandum that appears, if your Honours are interested, at page 3196, BHPDRI is referred to as the project entity.  You see an example of review in paragraph 36, review of the capital structure.  The review appears – again your Honours need not turn to it – at page 3195, and following that review there were the steps taken that are referred to in paragraph 36. 

Now, within that general context, as one would expect of the subsidiaries implementing within a broad framework the investment decisions of the parent company, if you look at the precise circumstances that prevailed on 30 November 1999 when Finance made the unsecured $2 billion loan to DRI by that book entry to which we have referred on the standard terms and conditions set out in paragraph 21 of her Honour’s judgment, the circumstances were these.  I will just list them.  I do not ask your Honours to turn to each page. 

DRI’s assets had been written down by $378 million in May 1998, recorded in paragraph 45 of her Honour’s judgment.  They had been written down by a further $530 million in May 1999, paragraph 47 of her Honour’s judgment.  In the year ended 31 May 1999 DRI had recorded an operating loss of $578 million leaving it with negative assets as at 31 May 1999 of $456 million, negative balance sheet $456 million.  You see that from the accounts that I have already taken your Honours to, volume 8, page 3160 and 3161.  So, it is in a negative asset position. 

There is a letter of comfort given by BHPB to DRI.  You would see that at volume 8, page 3129.  That is in existence, but it carves out the debt DRI owes to Finance.  So Finance does not even have the derivative comfort of knowing that DRI has a letter of comfort and, despite all of that, there is a letter that Finance has given to DRI, a letter that you will see at page 3278 – I got that wrong – a letter that was recorded at paragraph 48.  It actually appears at page 1700 within volume 4 which indicates that Finance had at that stage, 21 July 1999, no intention of calling on the debt for a period of 12 months.

One does not need, in our submission, the evidence of Mr Coburn, which is referred to in our written submissions, to draw the conclusion that the modus operandi of the BHP Group was to work out intra‑group obligations in the best interests of the group as a whole.  The reasonable conclusion can be drawn in the circumstances that if BHPB, in the interests of the group as a whole, saw merit in the continuation of the HBI project, it was capable of introducing such measures as would have been seen to be necessary or convenient, in the interests of the group as a whole, to ensure the long‑term survival of DRI, either by increasing the funding to DRI or by reducing its exposure. 

One of the ways of reducing its exposure would have been for Finance to waive the debt, effectively what Finance did in the circumstances of what occurred on 10 May 2000, or an alternative would have been for Finance to agree to limit its recourse in the event of default.  Effectively the same result from a BHP Group perspective could have been achieved by either of those alternatives, leaving tax considerations out of account, of course, as one needs to, in applying this subsection.

So what that means is that irrespective of the value of the rights Finance would have been giving up, if one only looked at the relationship of the parties and not the interests of the Group, it is reasonable to expect that Finance would have been prepared to agree to a variation of the loan to reduce the exposure of DRI if the survival of DRI in that way was seen by BHPB to be in the overall interests of the Group.

Now, your Honours, that, in our submission, is enough for there to be more than a theoretical capability so as to engage section 243‑20(2) and the result of that subsection being engaged is a reduction in the capital allowance deductions, worked out in accordance with Subdivision B and implemented in accordance with Subdivision C, all of that in circumstances where, looked at from a practical perspective, this special purpose vehicle, DRI, as part of the BHP Group, has never been fully at risk in relation to the amount of the expenditure.

GUMMOW J:   In the objection decision by the Commissioner in volume 1 at page 73, the Commissioner’s position respecting 243 may most clearly appear from the second and third paragraphs on page 73.  Is that really where we still are?

MR GAGELER:   Would your Honour just bear with me while I have a look at it.

GUMMOW J:   Yes.

MR GAGELER:   Your Honour is drawing my attention to the second paragraph and the ‑ ‑ ‑

GUMMOW J:   Yes.

MR GAGELER:   I am not sure about the third paragraph.  The reference to “some form of arrangement” is not something that I currently rely on.

GUMMOW J:   The third paragraph, the second and last sentence in the third paragraph:

therefore having an understanding that its recourse in the event of default would be limited.

Therefore, subsection 243-20 . . . recourse on the debt was limited.

MR GAGELER:   No, not really, because I am not arguing subsection (1) any more, your Honour, or arrangement, so I really cannot assent to what your Honour is putting to me.

GUMMOW J:   Well, is the case that is being put now reflected at all in the Commissioner’s decision?

MR GAGELER:   If your Honour looks on the same page, at about line 40.

GUMMOW J:  

look through arrangements ‑ ‑ ‑

MR GAGELER:   Yes.  Your Honour, the case has got clearer, crisper, I hope.

GUMMOW J:   It might be, but one has to write a judgment, and it is good to know how it all started off.

MR GAGELER:   Yes.

BELL J:   Before Justice Gordon, the emphasis was very much on subsection (1), was it not, in terms of considerations of practicality as well?  They were feeding in to subsection (1).

MR GAGELER:   Yes.

GUMMOW J:   Yes, I was going to ask you about that.

MR GAGELER:   I do not quite know what happened, your Honours.  She really stated a test in terms with which we would not particularly disagree, so far as it goes. 

GUMMOW J:   Where you do find error in the primary judge’s treatment of 243?

MR GAGELER:   It is what is not there, rather than what is there.  Paragraph 228 is not wrong, so far as it goes.

BELL J:   Is it not there because it was not put that way to her?

MR GAGELER:   It was not put as clearly as I now – I cannot criticise her Honour.  So far as it goes, I cannot say that paragraph 228 is wrong.  It is neutral.  Then her Honour goes to paragraph 229 and deals with the argument that was interpreted as an argument of economic equivalence.  Now, the argument was put in very broad terms.  I can accept that her Honour may ‑ ‑ ‑

GUMMOW J:   Well, an expression like “looking through”.

MR GAGELER:   Yes.  That is right.

CRENNAN J:   I think the Full Court said the argument was put in those terms, including being pressed in those terms, significantly before then.

MR GAGELER:   In economic equivalence terms?

CRENNAN J:   Yes, that the argument was put in those terms.

MR GAGELER:   No, I did not then and I certainly went nowhere near it.

CRENNAN J:   It is just that it is ‑ ‑ ‑

MR GAGELER:   I know I was there and I certainly did not put an economic equivalence argument – indeed, expressly disavowed it.  In the Full Court, your Honour – again to be fair to the members of the Full Court – the weight of the argument rested on subsection (1) and it was a reprise of the argument that was foreshadowed in the passage at page 73 that your Honour Justice Gummow drew attention to.  The Full Court again after the subsection (2) argument ‑ ‑ ‑

FRENCH CJ:   I think your argument is summed up at 95 in the Full Court judgment, is it not - 3433?  It is one paragraph in the alternative.

MR GAGELER:   Yes, that is right.  The argument is more refined, your Honours.  If the Court pleases, they are our submissions‑in‑chief.

FRENCH CJ:   Mr Bloom.

MR BLOOM:   I think it is fair to say that the arguments are more refined, your Honours.  They are more found for the first time in this Court.  To understand the judgments below, it is helpful to understand what was put below and it was done in such a way as to take the word “practical” out of subsection (5) and use as it as if it were a piece on a chess board and just move it around subsections (1) and (2).  So before the trial judge, the Commissioner argued that “rights”: in subsection (1) meant practical rights.  So it qualified “rights” and in subsection (1).

GUMMOW J:   The word “practical” coming from where in the first place?

MR BLOOM:   Well, it is not there, your Honour.  We agree, with respect.

CRENNAN J:   Well, I suppose subsection (5) has “not in practice limited”.

MR BLOOM:   Yes.  Well, that is of course, an exclusionary provision ‑ ‑ ‑

CRENNAN J:   Yes.

MR BLOOM:   And it is specifically used there.  It is not used in the inclusionary provisions of (1), (2) or (3).  In the Full Federal Court, the Commissioner argued that the word “practical” should, instead, qualify the word “limited” in subsection (1).  So if your Honours look at subsection (1) we go from an argument that rights are practical rights to an argument that the rights are practically limited. 

It is now conceded before this Court, and that is a major difference, that subsection (1) is concerned with legal, that is contractual limitations, and on legal rights.  Before this Court, he now argues and for the first time, that the word “practically”, another form of the word, should be read into subsection (2) so as to now qualify the word “capable”.  The answer is the answer given, with respect, by Justice Gummow.  The word does not appear anywhere in (1) or (2).

The question which is asked in (2) is whether it is reasonable to conclude that the rights of the creditors against the debtor, in the event of default, are capable, that is common ground at the time of the loan, of being limited in the way mentioned in (1).  That is the issue; reasonable to conclude, capable of being limited, rights capable of being limited.  Your Honours, there was some discussion between my learned friend, the Solicitor, and Justice Gummow about onus, but this was a case where, as in all tax cases, there were pleadings and the pleadings did not disclose the case which has now been put.  So to suggest that the case now being put was not met by evidence and that somehow results in an evidentiary problem for the taxpayer is, with respect, to go much too far.

What the Commissioner is asking this Court to do is to determine as a matter of fact, that is not an issue, whether it is reasonable to conclude, having regard to the four matters in subsection (2) or, indeed, as of yesterday he says three matters because he leaves out paragraph (b), that the relevant capacity existed at the date of the loan and the rollover was 30 November 1999.

GUMMOW J:   Sorry, when did (b) disappear?

MR BLOOM:   Paragraph (b) disappeared in his submissions in reply, your Honour.

CRENNAN J:   With the excisions of paragraphs 49 and 50.

MR BLOOM:   Yes, your Honour.

GUMMOW J:   Yes, I see.

MR BLOOM:   He says that not only are there no arrangements within the wide definition in 995, he says you do not take into account the fact that there are no arrangements.  This Court is asked to perform that task, the factual finding, without the advantages which the trial judge had of having read all of the evidence, seeing all of the witnesses, a process which in fact took many days and when one comes to the section, in our respectful submission, the capacity required by subsection (2) is a capacity which qualifies the rights.  It is those rights of the creditor against the debtor which must be, at the time of the loan, capable of being limited in the way it mentioned in (1). 

We accept that that might be pursuant to an arrangement, because one is directed to look at arrangements, and that arrangements may be enforceable or unenforceable.  They encompass promises, undertakings, understandings and they can be legally enforceable or not, but the capacity has to exist at the time of the loan and, your Honours, that requires, with respect, that there is either a contract or some sort of agreement or some sort of arrangement existing at the time of the loan pursuant to which that capacity is conferred.  The Commissioner’s submissions, in fact, are not concerned with capacity ‑ ‑ ‑

HEYDON J:   How can rights be limited by an arrangement, a non‑legally enforceable arrangement?  The rights would survive that.

MR BLOOM:   It is the capacity to limit the rights under an arrangement that we contend.  So the capacity qualifies the rights.

CRENNAN J:   If you had a side agreement that somehow was contra to the legal rights in some written agreement, is that the sort of arrangement the subsection is intended to catch?

MR BLOOM:   Yes, your Honour, or a nod or a wink.  I mean, it does not have to be enforceable.  But there must be something whereby you can say, looking at this loan, to distinguish it from the loans which fall within 245 - and all loans fall within Division 245, and I will come back to that in a moment – but to distinguish this as one which is intended to be a limited recourse loan, as defined, a specific species.

Let me just deal with 245 and 243 for a moment, if I may.  Division 245 applies to all debt forgiveness.  I do not intend to take your Honours to the provisions, but just to give you a general understanding of it.  Division 245 applies to the forgiven amount of a debt, and when that debt is forgiven, it will then reduce certain tax aspects of the debtor company.  In order, these are deductible revenue losses under 245-105(5), usually carry‑forward losses; net capital losses under 245-105(6); deductible expenditure, including capital allowance expenditure, under 245‑105(7) and the cost bases of certain assets under 245-105(8).

Now, usually, the deductions under Division 245 are deductions that go forward over a number of years, carry‑forward losses, for instance, and so the operation of Division 245 will continue over that period.  Division 243, on the other hand, gives the Commissioner more up front, because it will bring in the full amount of those capital allowances into the year of income and in the context of consolidation, where one has a solvent head company, it will come into the assessable income of that head company, even though the subsidiary which has actually incurred the losses is itself not in that happy position.

In this particular case, Division 243 works better for the Commissioner than 245.  It can be otherwise, and there is a tie-breaker in 243 which gives priority to 243 over 245, but having said that, 243 is not the general provision which 245 is.  Division 243 only applies to limited recourse loans as defined.  It does not apply wherever there has been a debt forgiveness and capital allowance deductions.

Your Honours, we agree, with respect, with what your Honour the Chief Justice said, that capacity for the purposes of two cannot exist merely because the parties have the ability, which all parties to a contract have, to subsequently vary or amend their contract, or enter into some unenforceable arrangement of that kind.  If I could just refer the Court to the decision of this Court in Commissioner v Sara Lee Household & Body Care (Australia) Pty Ltd 201 CLR 520 at pages 533 to 534, noting that the parties to a contract may always vary its terms by a subsequent agreement.

That cannot be the capacity, and our learned friends acknowledge that.  If that subsection (2) capacity could indeed be satisfied by the existence of the capacity to vary contracts, which always exists, then every loan used by a debtor, wholly or in part, to acquire relevant property would be a limited recourse debt, to which Division 243 applied and that is not, in our submission, the intention.  Rather, the capacity required is a capacity of a specific kind, namely, to limit the legal rights of recourse in the sense required by subsection (1) and it must exist, in our submission, at the time of the loan because of some contract agreement or understanding which confers it, albeit in enforceable or unenforceable terms. 

In his written submissions in‑chief the Commissioner asserted two arrangements that were alleged to exist at the time of the loan at that point and that was in paragraph 50, I will not take your Honours to it, but neither, as your Honours have seen, is now pressed.  Indeed, he now no longer alleges that any arrangement for the purposes of subsection (2) existed, but, as I have said to your Honours, the absence of any such arrangement, which we would have thought, with respect, is a critical factor, is given no weight at all by the Commissioner in applying subsection (2).  In other words, he says, well, (b) says any arrangements to which the debtor is a party, well, there are none, therefore, you do not go to (b).  We say the very absence of such arrangements is a relevant factor in determining whether it is reasonable to conclude the conclusion that is required, and reasonable, this Court has held in another context, in the context of Part IVA upon which our learned friends rely, means reliable.

GUMMOW J:   Are you saying that in the absence of (b), (a), (c) and (d) can never be sufficient?

MR BLOOM:   It would be a very unusual case, your Honour, a very unusual case.  The case put against us is that (a), (c) and (d) are sufficient in this particular case, but not only in the absence of (b), in the absence of any arrangement of the kind to which (b) applies it would be very difficult to see that (a), (c) and (d) by themselves, because one has to take into account, we say, that absence as the factor (b). 

FRENCH CJ:   What inference can one draw, for example, from the fact that a debtor and creditor are not dealing at arm’s length other than that there is some arrangement?

MR BLOOM:   Well, your Honour, that would usually be the sort of situation, must be too, not dealing with each other at arm’s length in relation to the debt.  So it must be a dealing in relation to the debt, and we would go one step further.  It must be a relevant dealing from which one would draw the reasonable conclusion and for that it would usually involve some sort of understanding, arrangement or something of that kind.  We have provided examples of three cases ‑ ‑ ‑

GUMMOW J:   What is the definition of this expression at “arm’s length”?

MR BLOOM:   At arm’s length?  It is in 995.  I do not think it is a definition of at “arm’s length” itself, your Honour.  Section 995 is the definition provision in the 97 Act as your Honour knows.  There is a definition just of “arm’s length” and it says, just to help one in reaching reasonable conclusions that:

in determining whether parties deal at arm’s length, consider any connection between them and any other relevant circumstance.

The definition of “arrangement” appears on the same page, your Honour:

arrangement means any arrangement, agreement, understanding, promise or undertaking, whether express or implied, and whether or not enforceable (or intended to be enforceable) by legal proceedings.

That sets a very, very low bar indeed and, in this case, nothing which comes within that definition is asserted against us.  Your Honours, we have provided ‑ ‑ ‑

CRENNAN J:   You would say, would you, that having in common, being subsidiaries of the same parent, is not enough in terms of a finding in relation to not dealing at arm’s length in relation to the debt.

MR BLOOM:   Correct, your Honour, yes, of itself.

CRENNAN J:   The circumstance of itself?

MR BLOOM:   Of itself, yes.  Your Honours, we have provided examples of three cases to illustrate the sorts of arrangements to which subsection (2) might apply.  These are illustrative only and we certainly do not suggest for a moment that they are exhaustive.  I do not need to take your Honours to the cases.  I will give your Honours a reference and tell you what they are about, but in Firth’s Case (2002) 120 FCR 450, there the loan agreement gave the debtor a contractual option to elect to repay the loan, not from his general funds, but rather from the proceeds of sale of the shares. If that option was exercised, the creditors’ recourse was limited to the amount that could be obtained from the sale of those shares. That would be the sort of situation to which subsection (2) would readily apply.

CRENNAN J:   Would there be special consideration involved, in terms of the loan, I mean?  Would that benefit, if you like, be taken into account in terms of the consideration for the loan?

MR BLOOM:   Yes, it was, and that was a case about – your Honour recalls it, I am sure – whether or not interest was fully deductible as a consequence.

CRENNAN J:   Yes.

MR BLOOM:   It was held that the interest was still fully deductible.  In Puzey v Federal Commissioner of Taxation (2003) 131 FCR 244, the loan arrangements gave the debtor a similar option with respect to the payment of interest. He could pay seven per cent or a certain percentage of what came in. Again, that sort of an option would be the sort of thing to which subsection (2) would readily apply in terms, at least, of the arrangement aspect of it.

The third example is provided by the facts of Esanda Ltd v Burgess [1984] 2 NSWLR 139, a decision of the Court of Appeal of New South Wales, and it is an example of a non-contractual arrangement, not directly in point, but it is a non-contractual arrangement. There, there was a bailment agreement, certain goods, a motor car. In order for it not to be a hire purchase agreement, under the relevant statute the bailee could not have an option to purchase the goods. An assurance was given by the bailor at the time of entry into the contract that the goods would be his at the end of the leasing term if he paid the residual. That was held by a majority of the Court of Appeal, Justice Priestley dissenting, that there was no contractual right or option, rather it was a non‑contractual or non‑enforceable understanding.

That sort of an understanding by virtue of the definition of arrangement would be within paragraph (b) in subsection (2) and if it dealt with limiting of rights to particular assets, would be the very sort of thing about which subsection (2) is talking.  We accept, your Honours, that while capacity must exist at the date of the loan and that it may be a capacity which is non‑contractual or unenforceable, nonetheless, we rely on the decisions in Keighery 100 CLR 66, especially at 86, and Sidney Williams (Holdings) 100 CLR 95 at page 111 to submit that the capacity must be a presently and immediately existing capacity and not a mere possibility.

FRENCH CJ:   What effect would you give in the context of subsection (2) to an advance significantly in excess of the available assets of the debtor?

MR BLOOM:   That said and knowing nothing else?

FRENCH CJ:   Yes.  Well, there may be other circumstances.  I am just asking whether that is a circumstance which one would take into account for the purposes of (2)(a)?

MR BLOOM:   It is not one of the four factors, but can I deal with that when I come to the facts here ‑ ‑ ‑

FRENCH CJ:   This is having regard to the assets of the debtor, is it not?

MR BLOOM:   One has regard to the assets of the debtor and then ‑ ‑ ‑

FRENCH CJ:   Suppose one finds that at the time of the loan the assets of the debtor were substantially less in terms of realisable value than the amount of the loan being made?

MR BLOOM:   But, your Honour, if that was right, one would go straight to (1), would not one, and say, in effect – and this was the way the argument was put below – well, in a practical sense, because that is what your Honour is really arguing for, in a practical sense the legal rights were limited from the word go to those assets.  Your Honour, does that mean that if a particular subsidiary buys a jumbo aeroplane using loan funds, even assuming that the amount is expended entirely on the jumbo, that due to the fact that an engine falls off in Singapore or something of that kind it is a devalued asset, that the same pertains?

FRENCH CJ:   I think one of the arguments put by Mr Gageler relates to the position of DRI’s asset at about the time of the last rollover, as reflected in the review.

MR BLOOM:   Yes, that argument, your Honour, takes entirely out of context what was happening.  What was happening, which her Honour the trial judge described, and I will come to this, as a series of diligent decisions ‑ ‑ ‑

FRENCH CJ:   I am sorry you are taking it into a factual context now, but your answers to that argument is that that is an argument for subsection (1), it is not an argument for subsection (2), can never be?

MR BLOOM:   Well, your Honour, it may be a factor when one looks at the assets, but of itself, with respect, no, we do not say that that is a loan having that capacity because it could well be that other assets are acquired by the company.  One just does not know when one gets to the end of the day whether a debt is or is not repaid, but, no, certainly we would not accept that of itself that gives rise to the capacity which must be found to exist under subsection (2).

CRENNAN J:   Although, could you not factor into the Chief Justice’s scenario a complete absence of security in relation to the lending and the lending way exceeding the asset position of the borrower.  Is that the kind of arrangement that perhaps subsection (2) is directed towards?

MR BLOOM:   It might be.  If that was the arrangement - certainly the loan itself, I suppose, is an arrangement – that might be but the rights of an unsecured creditor are not rights against any assets at all.  They are not rights against any specific asset of the debtor.  Unless one is going to take this sort of practical approach and then the question arises, where do you take it, at first instance in subsection (1) to rights in the Full Federal Court, to subsection (1) to limitations, here to capacity, with respect, reading the words of the section, if there is a loan – I mean, that would probably be not a factor (b) but a factor (d) that the parties were not dealing with each other at arm’s length in relation to the loan, but it is not this case, I add quickly, your Honours, because of the context in which that role overtook place and the history of the lending, all of which my learned friend chooses, with respect, to ignore.  Can I turn to the four factors here for the purposes of the exercise which my learned friend asks the Court to now perform, that is the factual exercise.

The assets included, but were not limited to, debt property.  There is a very detailed list of them that I will not take your Honours to, but it is exhibit R10 in appeal book 7.  A list of the property as at the 2000 year appears at 2579 to 2580.  The list includes 195 general purpose leases, assignable under section 119 of the Mining Act (WA) 1978.  Ernst & Young, your Honours, in their report misunderstood the nature of the leases.  They did not realise they were general purpose leases, but thought they were mining tenements under which the assets in fact reverted to the Crown at the end of the lease.  That is not the case.

There was a take or pay contract for gas, also assignable.  There were rights to use a gas pipeline, also assignable.  There were entitlements under a water supply agreement, also assignable, and there were contractual rights to purchase iron ore fines, which was a feedstock, of course, for the HBI manufacturing plant.

BELL J:   When you referred us to the exhibit, the number of which I have now forgotten, was this a reference to the evidence that her Honour refers to at 218 of the judgment, where she speaks of ‑ ‑ ‑

MR BLOOM:   Exhibit R10, yes.  That was the list, yes, your Honour.  Your Honours will see it is extremely detailed, and that is why ‑ ‑ ‑

BELL J:   Her Honour ended up, in the final sentence of paragraph 218, saying:

It was by no means clear that all of that property was located at or connected with the plant at Boodarie.

MR BLOOM:   Yes.  Her Honour went on to say, in fact, that there were great difficulties in applying 243 to a case like this.  There was $500 million or more subscribed in capital.  There was, in amongst the refinancing in November of 1999, a quarter of a billion dollars of interest.

That quarter of a billion could not have been used to finance the purchase of debt property.  The capital was, we know that, as were the loan funds, obtained by Finance from outside external sources.  What we were not able to demonstrate below on a tracing exercise was what was purchased.  I mean, this is a manufacturing plant of huge proportions, a beneficiation plant, the manufacturing plant, there are connections in pipes and all sorts of things, and these assets it would be impossible, as her Honour held, to identify in terms of a tracing process for funding, and people do not keep that sort of detail.  That led her Honour to say, at paragraphs 223 to 224, which appears at page 3338 – I think my learned friend took you to 223:

In the present case, the applicants concede that there probably was expenditure entirely funded by debt in some months (eg September and October 1995) but do not identify or even attempt to identify the capital expenditure and, in particular, the nature of the property acquired.  This form of analysis is, in my view, necessary because of the expanded definition of expenditure in s 243-30(1).  That section directs a broad enquiry beyond a mere identification of the property to consideration, inter alia, of expenditure on items otherwise connected with the property.  That enquiry is made all the more difficult in the present case, because the “property” in the most general terms consists of numerous items of plant and equipment as well as allegedly personal items of property, some or all of which comprise the HBI plant.  On the basis on the current evidence, one can infer from the amount and timing of the debt funding, the quantum of the capitalised expenditure on the assets of BHPDRI recorded in the books of account of BHPDRI, the asset register of BHPDRI and the timing of that expenditure, that the debt funding has been used to wholly or partly –

and that is all that really the Act requires, wholly or partly.  You could have 20 per cent of debt funding and 80 per cent of capital, and that would still be used partly if you could not do a tracing exercise.  Now, that leads her Honour to say in 224:

Although I have ultimately decided the question on the basis that the applicants failed to discharge their onus, the answer may in fact lie elsewhere.  On one view, the dilemma faced by the applicants supports the construction of Div 243 that I have adopted – Div 243 was never intended to apply to arrangements such as those the subject of these proceedings.  The alternative is that taxpayers claiming capital allowances under Div 40 should be in a position to identify each capital allowance, the source of funding for each capital allowance and the inter‑connectedness (if any) between items of expenditure.

Now, although my learned friend did not refer to it, he has provided your Honours with, as additional extrinsic material, the Ralph Report.  Now, in a moment I will remind your Honours of the part that played in relation to the passage of this particular provision, but if I could ask your Honours to go to tab 18 of our friend’s authorities, it is behind tab 18, 255, point 5 of the Ralph Report.

GUMMOW J:   What is the citation of the case?

MR BLOOM:   It is not a case, your Honour, it is the Ralph Report.

GUMMOW J:   The Ralph Report?

MR BLOOM:   The Ralph Report, yes, your Honour.  It is headed “Tax System Integrity”, your Honour.  At 255, point 5:

As noted, because of the fungibility of debt, a blanket rule requiring the matching of extinguishment gains or debt to losses on associated assets would be very difficult to administer.  Tracing is not an issue, however, where a limited recourse debt is used to finance the acquisition of property (to which the lender’s recourse is confined).  In such cases there is a clear nexus between the borrowing and the underlying property.  Matching will therefore be undertaken by treating extinguishment gains as capital gains to the extent that the loss on assets financed on a limited recourse basis is subject to capital loss quarantining.

So that really echoes, with respect, what her Honour said.  Having said that I should tell your Honours that she reached her conclusion without any reference to the Ralph Report, and that Division 243 was first announced in the May 1997 budget and then because of elections and whatnot was – well, it lapsed, the Bill when introduced lapsed in 1998.

The Ralph Report was released on 30 July 1999 between the passage of the Bill in the Lower and Upper Houses of Parliament.  So one cannot, in those circumstances, really, because the Ralph Report is not referred to in any of the speeches made in Parliament about the Bill, one cannot really, with respect, get anything from it as to the mischief which Parliament itself was trying to deal with.

Your Honours, we next go to paragraph (c), slightly out of order, and this paragraph must be read, in our submission, in the context of Finance’s rights as an unsecured creditor.  If I could shortly take your Honours to the decision in Inland Revenue Commissioners v Herdman (1969) 1 WLR 323. It was a scheme to get around United Kingdom tax and it relied upon certain specific provisions which have no materiality to your Honours, but at 327 in the speech of Lord Reid, he and all of their Lordships agreed with Lord MacDermott the Chief Justice below. At just above the letter B at 327, Lord Reid says:

I cannot see how it can be said that the respondent acquired any rights at all by means of these associated operations.  By means of the transfer of the shares to the new company he acquired two rights.  He acquired shares in the new company in the Republic and he became an unsecured creditor of that company for over £76,000.  Neither right gave him any right in or to particular assets of the new company.  The way in which that company dealt with its assets did not alter either of these rights.  It may have made them more valuable and it may have made it easier for the company to pay its debts but it did not change the respondent’s rights.

The contrary would be true, too, with respect.  If the assets became less valuable and it became less easy for the company to pay its debts, that still makes no change to the rights as unsecured creditor and it is not contested, of course that Finance was an unsecured creditor.  There is also the fact, which we rely upon, that there was never at any time any legal limitation on the rights of Finance in the event of default of the kind mentioned in subsection (1).  If I can come back to subparagraph (b), which the Commissioner would ask you not to look at ‑ ‑ ‑

FRENCH CJ:   Do you go so far as to say that the existence of some arrangement is a necessary condition of a reasonable conclusion for the purposes of subsection (2)?

MR BLOOM:   Your Honour, at one level yes.  We would prefer to put it this way.  It would be a very unusual case for that not to be so.  In this particular case we say that it is decisive.  One remembers, of course, the concession that there is no arrangement.  There is a concession that there is no understanding, no undertaking, no promise and no agreement whether enforceable or unenforceable. 

If I can come then to paragraph (d) upon which the Commissioner almost entirely relies.  The dealings, as your Honours know, to be scrutinised under this subparagraph are qualified.  They are dealings in relation to the debt.  In our respectful submission, again, they have to be relevant dealings, that is, dealings which might assist whoever it is who has to reach the reasonable conclusion in reaching that conclusion as to capacity. 

Now, in our respectful submission, the Commissioner has not correctly understood subparagraph (d).  It requires one to consider whether Finance and DRI, in this case, were dealing with each other at arm’s length in relation to the debt.  No submission has been made, apart from the loan itself, that there was any non‑arm’s length dealing answering that description.  Instead, really, his argument boils down to a rather different contention concerning the alleged capacity for the subordination of the corporate minds of Finance and DRI to that of their ultimate parent.

Now, capacity for third party control is not the matter to which subparagraph (d) is directed.  Moreover, such capacity for subordination was never put to any witness who gave evidence on behalf of the respondent or Finance, and nor is it supported by the evidence.

GUMMOW J:   I suppose there is quite a bit in corporations law emphasising the distinct nature of directors’ duties, as between one corporation and another, even in the same group, is there not?

MR BLOOM:   Absolutely, your Honour.  I do come to that very shortly, your Honour.  The Commissioner still relies upon this evidence of Mr Coburn, notwithstanding the number of times we have attempted to let him not rely upon it and he concedes now that notwithstanding the low bar in the definition of “arrangement” in section 995, whatever it was that Mr Coburn was giving evidence about was not an arrangement, so no understanding or anything of that kind. 

If I might call this the modus operandi evidence, a number of things can be said about it.  Firstly, Mr Coburn was giving evidence about what his understanding was when he signed the accounts of Titanium Minerals, a different company altogether, in the context of a letter of comfort provided to that company by the parent.  Secondly, can I take the Court to paragraph 22 of Mr Coburn’s affidavit, which is behind tab 13 of our materials.  It was not in the book because it dealt with Titanium Minerals.  He says, as your Honours will in those paragraphs:

The circumstances facing BHPTM at this time were, in my experience at BHPB, very unusual.  Prior to the late 1990s I had not been involved with a BHPB group company that had conducted significant operations that had failed. 

Indeed, if one looks at the profits of Finance over the various years, you will see that it is only the 2000 year that there was an accounting and tax loss out of all the years that are extracted.  But the point is, he could not be giving evidence about a modus operandi that included things with which he had no experience and which were unusual.  The other thing is that he was not a director of BHPB Billiton.  He was not a director of Finance.  He was not a director of DRI.  The evidence as to his position in the Group as an accountant is put as with much, with respect, of the Commissioner’s case, very selectively. 

Could I ask your Honours to turn to appeal book 4 at 612 - 1612, I am sorry, your Honours.  I cannot read my own writing.  Either that, or I am standing too close to my learned friend and picking up his bad habits.  In paragraph 5 at the bottom of page 1612:

During my time as Group General Manager, BHP Minerals Finance, I was responsible for the financial aspects of the businesses conducted by the BHPB minerals group.

The extract for your Honours from our learned friends stopped there.  He goes on:

These aspects included responsibility for management accounting, budgeting and preparing the statutory accounts for most of the entities within the BHPB Minerals group.

That included DRI.

It was also my responsibility to ensure compliance with BHPB group policies and procedures in preparing capital approval submissions and in ensuring that capital expenditure budgets were adhered to if there were expenditure overruns, that the relevant further approvals from BHPB were obtained.

Then in paragraph 6, he says at about line 7 or 8:

To the extent that the forecasts suggested a shortfall of cash, it was the responsibility of group Treasury to arrange the necessary funding. 

He was not a part of group Treasury.

It was my experience that loans from BHP Billiton Finance Limited represented the principal source of funding for domestic operations and projects.

Then at the very end of that paragraph, last two sentences:

This process did not require me to address the legal structure of the entity which would conduct the project or the form of financing that would be provided to the entity.  Rather, I was required to focus upon the overall economics and strategic fit of the proposal within the BHPB group generally.

While your Honours there, if I may just point to some unchallenged evidence, paragraph (a) at 40 on the right‑hand side, and he is talking about the DRI plant when it began:

It was expected that the sale of the iron briquettes to be produced would be profitable as a result of the fact that their expected sale price would exceed their cost of production.

He goes on to say that the question was, really, one of the cost of feedstock.  Your Honour, the existence of this alleged modus operandi was not put to Mr McGregor.  I am sorry, I do see the time, your Honour.

FRENCH CJ:  Yes.  I think that might be a convenient time.

MR BLOOM:   If your Honour pleases.

FRENCH CJ:   The Court will adjourn until 10.00 am tomorrow.

AT 4.19 PM THE MATTER WAS ADJOURNED
UNTIL WEDNESDAY, 8 DECEMBER 2010