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BHP BILLITON FINANCE LTD v FC of T; BHP BILLITON LTD v FC of T

Judges:
Gordon J

Court:
Federal Court, Melbourne

MEDIA NEUTRAL CITATION: [2009] FCA 276

Judgment date: 30 March 2009

ATC 9491

Gordon J

Introduction

1. These proceedings concern BHPB and three of its subsidiaries - Finance, BHPDRI and BHPTM. Finance, the internal financier to the BHPB Group, financed projects approved by the board of directors of BHPB both initially and on an on-going basis, including projects constructed and operated by BHPDRI and BHPTM.

2. In the 2000 year, two projects partly financed by Finance - the HBI plant for which BHPDRI was responsible and the Beenup Project for which BHPTM was responsible - had not been successful. Finance wrote off as bad part of the debt owed by BHPDRI and part of the debt owed by BHPTM. The amounts written off by Finance in the 2000 year were:

  • 1. $1,845,833,281.34, of a total debt of $2,191,833,281, due to it by BHPDRI. (There is a discrepancy of $0.34 which may be put to one side); and
  • 2. $310,881,702.40, of a total debt of $339,216,146.22, due to it by BHPTM.

3. It is the writing off by Finance of these parts of the two debts (the BHPDRI loan and the BHPTM loan) in the 2000 year which is in issue in these proceedings. Two consequential steps for tax purposes were taken. First, Finance claimed as a deduction the amount written off pursuant to s 25-35 of the 1997 Act. Secondly, BHPB applied the debt forgiveness provisions to those write offs (Div 245 in Schedule 2C of the 1936 Act) but not the provisions concerning limited recourse debt in Div 243 of the 1997 Act.

Issues and summary of conclusions

4. The writing off of part of each debt raises five issues:

  • 1. whether Finance was entitled to an allowable deduction in respect of each amount written off as bad pursuant to s 25-35(1)(b) of the 1997 Act. The central question is whether Finance was in the business of lending money and, if so, whether each loan was made by Finance in the course of that business. In relation to the BHPTM loan, there is a further issue about whether the loan was bad;
  • 2. alternatively to (1), whether Finance was entitled:
    • (a) pursuant to s 8-1 of the 1997 Act, to an allowable deduction in respect of each amount written off as bad;
    • (b) pursuant to s 25-35(1)(a) of the 1997 Act, to an allowable deduction of $424,204,013 in respect of the BHPDRI loan and $95,892,428 in respect of the BHPTM loan. These amounts related to interest which accrued under the loans and which had previously been included in Finance's assessable income;
  • 3. if yes to (1) or (2) in relation to that part of the BHPTM loan written off as bad, whether the Commissioner made a valid determination pursuant to Pt IVA of the 1936 Act to cancel that bad debt deduction claimed by Finance;
  • 4. in the BHPB Proceedings, whether Div 243 and Pt 3-90 of the 1997 Act apply to disallow capital allowance deductions claimed by BHPB as head entity of a tax consolidated group in respect of assets of BHPDRI. The central question is whether the BHPDRI loan was limited recourse debt for the purposes of Div 243;
  • 5. finally, if BHPB and Finance were unsuccessful in whole or in part in these proceedings, the question of the additional tax imposed by the Commissioner.

5. For the detailed reasons that follow, I consider that:

  • 1. Finance was entitled to an allowable deduction in respect of each part of the debt written off as bad pursuant to s 25-35(1)(b) in the 2000 year. Finance was in the business of lending money and each loan was made by Finance in the course of that business. Moreover, contrary to the Commissioner's submissions, the amount of the BHPTM loan written off was bad;
  • 2. although these questions do not arise for consideration, nevertheless:
    • (a) pursuant to s 8-1 of the 1997 Act, Finance would have been entitled to an allowable deduction in respect of each amount written off as bad;

    • ATC 9492

      (b) s 25-35(1)(a) of the 1997 Act was not engaged. There was no interest written off as bad;
  • 3. in relation to the BHPTM loan written off as bad, the Commissioner was entitled to rely upon s 169A(3) of the 1936 Act in making his s 177F(1)(b) determination. However, Pt IVA did not apply to otherwise disallow the allowable deduction in respect of the amount of the BHPTM loan written off as bad pursuant to s 25-35(1)(b);
  • 4. in the BHPB Proceedings, Div 243 and Pt 3-90 of the 1997 Act did not apply to disallow capital allowance deductions claimed by BHPB as head entity of a tax consolidated group in respect of assets of BHPDRI. The BHPDRI loan was not limited recourse debt for the purposes of Div 243;
  • 5. in light of my earlier findings, the question of additional tax does not arise. However, if I am wrong in any of the conclusions I have reached, I would have remitted a substantial part of the additional tax imposed by the Commissioner. The position adopted by BHPB and Finance was reasonably arguable.

Facts

6. The facts relevant to the BHPB Group and the manner in which the group was managed are primarily sourced from the affidavits sworn by Mr Graeme McGregor, a former director of both BHPB and Finance and Mr Basil Ahyick, who was appointed in August 1994 as Finance's "Supervisor Accounting", appointed in January 1996 as "Financial Accountant [BHPB] Finance and Investments" and then appointed in January 1998 as "Team Leader SAP R/3 Project, [BHPB] Budgets and Accounting". Their evidence in relation to these matters was not the subject of challenge.

The BHPB Group

7. BHPB was incorporated in 1885 and is the ultimate parent company of a diversified group of multinational natural resource companies. In the 1990's, the period with which these proceedings are primarily concerned, the BHPB Group's principal areas of business were: the minerals group which undertook minerals exploration, production and processing principally of coal, copper, iron ore and manganese ore; the petroleum group which undertook hydrocarbon exploration, production and refining; and the steel group which undertook steel production and group corporate services.

8. The BHPB Group's corporate services group provided transactional services to other members of the BHPB Group including in the areas of finance, treasury and accounting, human resources and supply and procurement. Finance, the applicant in VID 788 of 2006, formed part of the treasury section of the corporate services group.

Finance

9. Finance was incorporated on 29 August 1975 as a wholly owned subsidiary of BHPB "for the purpose of borrowing funds to re-lend to Group companies". Its Memorandum of Association records one of its objects is "to carry on the business of financier in all its branches both within and outside Australia".

10. From September 1985, Finance was registered as a financial institution and a short term money market dealer / operator for the purposes of the Financial Institutions Duty Act 1982 (Vic) and s 98I of the Stamp Duties Act 1920 (NSW) [repealed by the State Revenue Legislation Amendment Act 2008 (NSW)]. By the early 1980's, Finance had commenced raising finance from external lenders. From the early 1990's, virtually all external borrowings of the BHPB Group to fund activities and projects of the BHPB Group were undertaken by Finance.

11. Centralisation of the financing activities of the BHPB Group within Finance provided, what were described as, numerous "administrative and corporate efficiencies" including ensuring that lenders and financiers dealt with one entity whose business could be readily understood by the finance community, centralisation of the foreign exchange operations of the BHPB Group for better monitoring and control of the group's total foreign exchange exposure and hedging activities (with foreign exchange gains and losses being treated on revenue account) and enhanced transparency of the BHPB Group's financial results by separating financing activities from operations.

12.

ATC 9493

As the principal financier, Finance raised money from financial institutions outside the BHPB Group by way of loan facilities, the issue of commercial paper and medium term notes. Each year, the BHPB board set the borrowing limits and the borrowing program to be carried out by Finance for the next 12 months. That program stipulated the proportions of short and long term debt, the mix of fixed and floating interest rate debt and the mix of currencies in which funds were to be borrowed. For example, for the financial year ended 31 May 1996, the BHPB board granted approval for loan and other financing facilities in the name of Finance (or any other wholly owned subsidiary) for an amount not exceeding $2,275 million. A committee of the board, consisting of two or more of the Managing Director, the Executive General Manager Finance and the Corporate Treasurer was appointed for the purposes of, inter alia, "[a]pproving, executing, delivering and performing all terms and conditions and documentation of loan and other financing facilities to be arranged by [Finance] or any other wholly owned subsidiary up to a total of $2,275 million and all terms and conditions and documentation of guarantees to be issued by [BHPB] in respect of these facilities".

13. Consistent with the annual resolutions of the board of BHPB, over the relevant period Finance raised large sums of money from a variety of sources:

  • 1. From banks and financiers outside of the BHPB Group by way of medium to long term facilities and by way of short to medium term facilities. In the period from 17 December 1986 to 8 May 1996, Finance was the borrower under medium to long term facilities totalling billions of dollars in various currencies from numerous international financial institutions including:
    Agreement Date Lender Amount Borrowed
    17 Dec 1986 Industrial Bank of Japan Ltd; Fuji Bank Ltd; Long Term Credit Bank of Japan Ltd; Mitsubishi Bank Ltd; Sanwa Bank Ltd; Sumitomo Bank Ltd; Tokai Bank Ltd USD66 million / JPY25.0789 billion
    17 Dec 1986 Export - Import Bank of Japan JPY25.0789 billion / USD66 million
    16 Apr 1987 Dai-Ichi Mutual Life Insurance Co; Mitsui Bank Ltd (as Lenders); Mitsui Bank Ltd (as Agent) JPY7.1 billion
    14 Jan 1988 Sanwa Bank Ltd USD100 million
    29 Apr 1988 Mitsubishi Bank Ltd USD100 million
    31 May 1988 Long Term Credit Bank of Japan Ltd; Asahi Mutual Life Insurance Co JPY6.25 billion
    21 Jul 1988 Long Term Credit Bank of Japan Ltd; Nippon Life; Long Term Credit Bank of Japan Ltd (as Agent) JPY6.62 billion
    26 Jul 1988 Sumitomo Life Insurance Company JPY5 billion
    27 Jul 1988 Dai-Ichi Mutual Life Insurance Co; Industrial Bank of Japan Ltd; IBJ Australia Bank Ltd (as Arranger); Industrial Bank of Japan Ltd (as Agent) JPY6.62 billion
    27 Jul 1988 Dai Ichi Kangyo Bank Ltd USD10 million
    27 Jul 1988 Nissan Mutual Life Insurance Company JPY5 billion
    23 Sep 1988 Taiyo Mutual Life Insurance Co; Kyoei Life Insurance Co; Saitama Bank Ltd; Shizuoka Bank Ltd; Gunma Bank Ltd; Suruga Bank Ltd; Toho Bank Ltd; Bank of Osaka; Senshu Bank; Bank of Tokyo Ltd (as Arranger and Agent) JPY10.1625 billion
    15 Mar 1989 Export - Import Bank of Japan USD175 million
    9 Mar 1989 Nippon Dantai Life Insurance Co Ltd; Sumitomo Marine and Fire Insurance Co Ltd; Tokio Marine and Fire Insurance Co Ltd; Yasuda Fire and Marine Insurance Co Ltd; Daido Mutual Life Insurance Co; Nichido Fire & Marine Insurance Co Ltd; Bank of Tokyo (as Lead Manager and Agent) USD75 million
    28 Apr 1989 Westpac Banking Corporation AUD100 million

    ATC 9494

    26 Aug 1991    		 Kredietbank N.V. USD50 million
    26 Nov 1992 Dai-Ichi Mutual Life Insurance Co; Sakura Bank Ltd (as Agent) JYP6.22 billion
    18 Jan 1993 Sanwa Bank Ltd USD100 million
    3 Jun 1994 Mitsui Trust Finance (Australia) Ltd USD100 million
    19 Apr 1996 JP Morgan Australia Ltd USD250 million
    8 May 1996 Banque Nationale de Paris and BNP Pacific (Australia) Ltd USD200 million
  • 2. By the issue of promissory notes and commercial paper to raise short to medium term finance such as:
    Date of Finance
    Resolution     		Facility approved
    25 Oct 1985 US$700m note issuance facility
    25 Oct 1985 US$300m (maximum total) Euro commercial paper program
    29 Nov 1985 US$150m raising by issue of 10% US$ Eurobonds
    23 Sep 1986 US$200m floating rate notes issue
    21 Jan 1987 US$75m raising by issue of 14.25% guaranteed notes
    27 Feb 1987 US$50m raising by issue of notes
    19 May 1987 Unsecured promissory notes facility (increase of limit to A$300m)
    19 Oct 1987 A$80m (total face value) 12.5% fixed rate notes issue
    16 Feb 1988 A$100m bill facility
    24 Feb 1988 A$400m bill endorsement/discount facility
    24 Feb 1988 A$400m underwritten bill endorsement/discount facility
    31 May 1988 A$55m (total face value) convertible bill facility (to US$ loan)
    06 Jun 1988 A$150m Asian commercial paper program
    23 Nov 1988 A$500m (total face value) fixed rate unsecured notes issue
    22 Dec 1988 A$55m (total face value) convertible bill facility (to US$ loan)
    23 Feb 1990 $A110m (total face value) convertible bill facility (to US$ loan)
    27 Feb 1990 A$1b commercial paper facility involving issues of promissory notes
    02 Aug 1991 Asian commercial paper program facility (A$150m increase to A$300m)
    23 Feb 1993 A$1b commercial paper facility involving issue of promissory notes
    25 May 1993 US$700m note issuance facility
    13 Apr 1994 US$300m Euro commercial paper program (in conjunction with [BHPB] - Hamilton Oil Great Britain PLC)
    20 Dec 1995 US$700m note issuance facility
    26 May 1997 US$100m medium term floating rate notes issue
    18 Nov 1997 A$1b commercial paper program
    06 Oct 1998 US$450m standby note issue facility
    06 Oct 1999 A$3b medium term note program

14. In addition, Finance entered into interest rate and currency exchange swaps with third party financial institutions to limit exposure to risks of fluctuations over the short and long term. Samples of some of the agreements entered into by, and information memoranda issued by, Finance were tendered in evidence. In respect of each loan agreement in evidence, Finance was the borrower with its obligations guaranteed by BHPB. It was also the issuer of the information memoranda (guaranteed by BHPB) and it was the contracting party to the Master Swap agreements (with the obligations guaranteed by BHPB).

15.

ATC 9495

During the 1990's, Finance's board comprised senior executives from the BHPB Group. By way of example, from 1996 to 1999, Mr GW McGregor, the Executive General Manager Finance for the BHPB Group, was also a director of both BHPB and Finance.

16. Finance did not have its own staff. It utilised the services of BHPB for which it paid management fees. The fees reflected the proportion of time BHPB personnel spent in providing services to Finance. In the case of Finance, most of the services provided by BHPB were accounting and treasury personnel.

17. The BHPB treasury personnel had responsibility for determining the cash flow requirements of the BHPB Group using data provided by the operating divisions and relevant corporate staff, arranging the funding of those requirements and determining the form in which the funds would be raised. Performance of those tasks was subject to "Treasury Guidelines" prepared annually by the Treasurer & Vice President Corporate Finance which were then reviewed by the Chief Financial Officer and ultimately approved by the BHPB board. The guidelines provided a series of rules and protocols for a wide range of matters including credit limits (the total amount that could be borrowed from third parties), foreign exchange risk management, guarantees, interest rate and currency swaps, loan facilities and money market activities.

18. The cash flow requirements of the BHPB Group were assessed on an annual basis through the preparation of annual rolling budgets. Each business unit prepared a budget. Those budgets were then aggregated to form the BHPB Group budget which was ultimately approved by the BHPB board. Preparation of the BHPB Group budget commenced in the March preceding the commencement of the next financial year. The budget forecasts (cash inflows and cash outflows) were prepared for five years on a rolling basis. The forecasts took into account "operating revenues, new (and yet to be approved) capital investments, capital expenditure sustaining existing projects, exploration expenditure and operating costs". Once the budget was approved by the BHPB board, the budget necessarily identified the cash flow shortfall.

19. The manner in which the shortfall was funded was determined by the Corporate General Manager Taxation, the Corporate Treasurer and, ultimately, the Corporate General Manager Accounting. During the relevant period, the policy was recorded in Section 21.19 of the BHPB Accounting Policy Manual as at May 1996 entitled "Funding of Group Companies" in the following terms:

"Details of proposed equity and / or debt funding of new group companies, or of revised funding structures for existing group companies, should initially be provided to the Corporate General Manager Accounting.

Proposals will be passed on to the Corporate General Manager Taxation and to the Corporate Treasurer for review.

The Corporate General Manager Accounting will provide Business Groups with a written "sign off" once the Corporate General Manager Taxation and the Corporate Treasurer have indicated that the proposed funding structure is acceptable. The proposed funding structure should only be put in place upon receipt of this "sign off".

Continuous Review

Capital funding structures of controlled entities should be reviewed regularly to ensure that the structure remains appropriate to the entities' operational and financial standing.

For example, the 100% debt funding of an existing company's activities, other than on a temporary basis, is generally considered to be inappropriate. Similarly a company with high debt and little equity may need to have its structure reviewed if the consequential interest burden is leading the company into negative shareholder funds.

Reviews of company funding structures must be done in collaboration with the responsible taxation officer."

20. Before turning to consider the projects the subject of dispute in these proceedings, other aspects of the funding of group companies should be noted. First, most BHPB Group companies with bank accounts in Australian currency were part of an ANZ (AFT) sweep facility arranged through Finance. At the end of each day, each account balance was

ATC 9496

automatically transferred to a single bank account held by Finance. A similar arrangement was set up between Finance and Chase Manhattan Bank for BHPB Group companies with bank accounts maintained in US dollars. A positive bank account of a BHPB Group subsidiary swept to Finance resulted in a credit to the subsidiary's loan account with Finance and each negative balance swept to Finance resulted in a debit to the subsidiary's deposit account with Finance. Any surplus cash would then be placed by Finance on the overnight money market with third party financial institutions.

21. Secondly, as a result of the process of capital expenditure approval, selection of appropriate funding structures and the banking arrangements referred to in these reasons for decision, the value of loans made by Finance to BHPB Group companies totalled billions of dollars. For example, in the 1995 and 1996 years of income, Finance made loans to the entities listed in Schedule A totalling in excess of $17 billion. Finance had standard lending terms for the inter-company loans which, for the relevant period, were adopted by resolution of the board of Finance on 30 November 1994. Those terms provided:

"… intercompany loans granted by [Finance] to [BHPB] or its subsidiaries (together the "[BHPB] Group") from 1 December 1994 will, unless special terms are negotiated for a particular loan, be subject to the following conditions:

  • a) The interest rate will be 10.45% per annum or such other rate as may be nominated in advance from time to time by [Finance] as the relevant [BHPB] Group intercompany loan rate. Such interest shall be due and payable within 21 (twenty-one) days of the day on which the relevant outstanding loan is repaid.
  • b) Loans are to be made up of such amounts and are to be advanced on such dates as are agreed orally from time to time by the borrower and [Finance]. Each initial loan and each additional loan is to be for a period not exceeding five months at which time all loans shall become immediately repayable.
  • c) The currency of each loan will be Australian Dollars.
  • d) The application of the loan funds will be to fund normal operating activities including research and development where applicable, of the borrower.
  • e) Commitment fees will not apply.
  • f) Unless otherwise designated, any repayments shall be applied to reduce the earliest outstanding advance and then be applied first against individual loans in excess of $50,000.
  • g) For administrative convenience, each loan made by [Finance] under this arrangement will be entered into the one loan account. However it is acknowledged that each amount advanced is a separate loan.
  • h) [Finance] will consider renewing loans at the close of each five month period should the borrower advise (orally) that it wishes to do so."

22. One relevant change to these terms and conditions was an adjustment to the inter-company interest rate on 3 March 1995 as a result of a review undertaken by officers from the departments of Corporate General Manager Taxation and Manager Corporate Accounting. After that review, the Corporate Treasurer recommended the following rates apply:

" Australian Dollars

11.40% on funds advanced by [Finance]
7.40% on funds borrowed by [Finance]

Where interest payments/receipts are made/received sixty (60) days in advance, the following rates apply:

11.20% on funds advanced by [Finance]
7.20% on funds borrowed by [Finance]

…

Would you please ensure that all subsidiaries are advised of these rates."

23.

ATC 9497

As a result of the standard loan terms and in particular cll (b) and (h) of those loan terms (see [21] above), each loan from Finance to a BHPB Group member (including BHPDRI and BHPTM the subject of dispute in these proceedings) was for a five (5) month term.

24. It is not in dispute that the interest rate charged on loans from Finance to BHPB Group companies was higher than the interest rate at which it borrowed those funds from external third parties and from other members of the BHPB Group. Interest derived by Finance on the loans made to BHPB Group members accrued on a daily basis and was returned as assessable income on an accruals basis in Finance's income tax returns. As a result of the activities of Finance, it earned substantial interest income generating substantial accounting profits after tax and taxable income. The gross interest income, the accounting profits (after tax) and the taxable income of Finance from 1986 to 2002 (before rebates and deductions for tax losses carried forward by or transferred to Finance) was as follows:

Year Interest Income $AUD Accounting Profit After Tax Taxable Income
1986 1,409,469,373 90,229,086 114,154,910
1987 1,794,112,745 45,731,000 145,313,519
1988 1,260,286,254 536,068,290 76,965,039
1989 1,644,366,392 73,856,000 447,133,044
1990 2,123,000,365 453,106,000 148,808,478
1991 2,087,256,717 238,153,000 405,246,887
1992 1,513,908,695 44,180,632 169,544,782
1993 1,321,699,224 15,031,321 41,524,496
1994 1,005,508,556 231,322,166 (23,127,060)
1995 1,307,201,673 (276,567,336) 44,058,249
1996 2,131,370,433 480,571,938 531,718,141
1997 2,416,871,606 210,122,000 557,555,284
1998 2,171,794,804 (369,118,000) 422,385,267
1999 2,385,768,312 688,988,000 533,496,381
2000 2,935,745,157 (1,321,184,222) (1,659,815,608)
2001 3,305,477,562 80,730,978 776,410,060
2002 3,178,358,105 1,581,916,863 1,679,638,947
TOTAL $34,042,195,973 $2,803,137,716 $4,411,010,816

25. It is necessary to consider separately the projects constructed and operated by BHPDRI and BHPTM, the subject of dispute in these proceedings.

BHPDRI

26. This project involved the construction of a HBI plant at Port Hedland in Western Australia to produce briquettes from iron ore fines which, in 1995, were not only considered to have little if any economic value but were an impediment to the extraction and sale of ore because of the area required to store the fines. The intention was that "the production and sale of HBI would convert fines with little value to a valuable product and would provide further economic value for the BHPB group" by: (1) enabling more lump ore to be extracted and sold; and (2) satisfying obligations imposed upon BHPM by the Western Australian Government to undertake secondary processing of iron ore in that State.

27. Advice and assistance was sought by BHPIO (TB Janes) about the capital structure of BHPDRI in June 1995. At that time, BHPDRI had paid up capital of $20 million and a submission to the BHPB board seeking approval for expenditure to build a HBI plant near BHPB's Port Hedland operations had not yet been considered by the BHPB board. If the total expenditure for the project was ultimately

ATC 9498

approved, $300 million was forecast to be spent in the 1996 year. On the assumption that approval from the BHPB board was obtained, on 15 June 1995 BHPIO requested advice and assistance on the preferred capital structure and debt/equity mix and to put the necessary arrangements in place for the issue of additional equity, the establishment of an appropriate inter-company loan and to ensure that the internal funding procedures were correct.

28. On 16 June 1995, the Chief Executive Officer of BHPM (Mr JK Ellis) sought approval from the BHPB board for the expenditure of A$1,550 million to build the HBI plant near BHPIO's Port Hedland operation. The HBI capital expenditure submission recorded that based on 100% BHPB ownership of the project's assets (other than the tunnel), inter alia:

  • 1. the nominal IRR of the proposal was 22.1% (17.7% real) with a payback period of 5 years from project completion in June 1998;
  • 2. the incremental NPV was:
    A$M
    at 15% discount rate on real cashflows 160
    at 12.5% discount rate on nominal cashflows 870
    at 8.25% discount rate on real cashflows 940
  • 3. the forecasted results reflected the strategic and incremental benefits to the BHPB Group as a whole and, in particular, BHPB's iron ore business, from the construction of the proposed HBI plant.

29. The BHPM Capital Procedures Manual in place in June 1995 dictated the structure and content of capital expenditure submissions including the HBI capital expenditure submission. For example, it was the Manual which required, inter alia, that:

  • 1. submissions were authorised by the BHPB board on the basis of their BHPB Group impact and therefore had to be presented from that perspective. All inter-business group and inter-divisional group implications had to be considered including the strategic importance to BHPM, the relationship or impacts on the performance of other parts of BHPB and the rationale supporting the expenditure: Sections 2.2, 3.2, Appendix 1 - Submission Checklist.
  • 2. all projects had to be in the first instance evaluated on an ungeared or unleveraged basis to highlight the basic return on total assets employed by the project: Appendix 4 - Common Pitfalls of Investment Analysis.

30. The board submission (see [28] above) was supported by a two volume feasibility report comprising (1) a detailed HBI Facility Financial Model and (2) BHPIO Consolidated and Entity Financial Summaries which had been prepared on two distinct bases. Summaries for ten entities were included, one of which was BHPDRI. Each entity summary considered the project on a stand alone basis for that respective entity on stated assumptions. For BHPDRI, on the assumptions stated, the summary assessed the HBI plant as having a nominal DCF rate of return of 3.5% over 20 years or with an NPV at 10% of negative $606 million. On 20 June 1995, consistent with Section 21.19 of the BHPB Accounting Policy Manual as at May 1996 entitled "Funding of Group Companies" (see [19] above), the Corporate Treasurer reviewed the HBI capital expenditure submission and expressed a number of concerns about the proposal to the Executive General Manager Finance.

31. On 28 June 1995, BHPM (Taxation) provided the advice sought by BHPIO in its memorandum of 15 June 1995 (see [27] above). The advice was in the following terms:

"In response to your note of 15 June 1995, I feel it will be appropriate for BHPDRI to continue as the project entity.

Consideration should be given to funding with debt up to a level which is consistent with commercial debt funding levels for major industrial undertakings. You will recall that in the case of the Pilbara Energy project, a debt:equity ratio of approximately 3:1 was arrived at.

I envisage that [Finance] would lend to BHPDRI at the inter-company rate of interest.

…

ATC 9499

There would be a very substantial pool of tax losses generated in this entity in initial years of development and operation from interest, R&D and capital depreciation. This will provide [BHPB] the desirable flexibility to utilise such tax losses under group tax relief arrangements to offset income and tax payments in other parts of the [BHPB] group. If [BHPB] invites future external participation in the project, arrangements should be structured to allow BHPDRI to remain a 100% [BHPB] entity so that project tax losses could continue to be transferred for the benefit of the Group. …"

32. The next day, 29 June 1995, the board of BHPB approved capital expenditure of A$1,550m on the HBI project. The presentation to the BHPB board was made by the Chief Executive Officer of BHPM, Mr JK Ellis. Subsequent to the presentation and in response to questions raised during the presentation, on 5 July 1995 further details were provided by Mr Ellis to the Managing Director of BHPB about the profit impact of additional ore sales and the composition of the consequential capital of $1,200m included in the HBI cash flow analysis.

33. What then occurred was not explained other than in the most general terms. However, the loan facility for BHPDRI was established with Finance. It was not in dispute that the terms of that loan were in accordance with Finance's standard lending terms for inter-company loans which were adopted by resolution of the board of Finance on 30 November 1994 set out at [21] above.

34. As a result of the standard loan terms and in particular cll (b) and (h) of those terms (see [21] - [23] above), each loan was for a five (5) month term. To accommodate the fact that at the end of each five month period a fresh advance was made, there were two loan accounts for the loan to BHPDRI from Finance - account numbers 325320 and 326320 - which were used for alternate 5 month periods. Initially loan account 326320 was used. The opening entry in that account on 31 July 1995 was a debit entry of $8,200,137.58 with the notation "I/CO TRANSFER REF G KERNI". On 1 October 1995, that loan account with a debit balance of $20,422,717.50 was closed and a new advance in the sum of $20,422,717.50 was made by Finance to BHPDRI in account number 325320.

35. In October 1995 and May 1996, the directors of BHPDRI resolved to allot 35 million and then, subsequently, 75 million $1.00 shares to BHPM Holdings.

36. During September and October 1996, an exhaustive review of the HBI project was undertaken. As a result of that review, two events occurred in November 1996. First, on 12 November 1996, BHPIO (T Janes) revisited the question of the capital structure of BHPDRI which had been adopted in June 1995 (see [31] above) and secondly, BHPM sought approval from BHPB for additional capital expenditure of A$140 million over and above that approved in June 1995. That capital expenditure submission was prepared in accordance with the Applicable Capital Procedures Manual then in place dated October 1996.

37. Prior to the further capital expenditure submission being considered by the BHPB board, both the question of the appropriate debt/equity mix and funding structure for the capital expenditure, consistent with the BHPB Accounting Policy Manual (see [19] above), was considered by Corporate Taxation. Approval was received for:

  • 1. an equity investment of $370m to be made by BHPM Holdings in BHPDRI after 31 December 1996; and
  • 2. to continue the equity funding of BHPDRI on the basis of a 50 / 50 debt to equity ratio (as had existed).

38. In reaching those conclusions, the required debt to equity level was considered. The advice provided by BHPM Taxation on that issue was that:

"… it has been seen that the selection of a debt to equity ratio is a matter of choice. The selection should therefore take into account the intended purpose of the company. This company will primarily be involved in the export sale of beneficiated product where it maybe [sic] competing directly with local suppliers in foreign countries. From past experience with claims that our companies are resorting to unfair competition by

ATC 9500

dumping produce on foreign markets based on the observation that the particular companies never make any profits we need to ensure that this company is not saddled with a level of debt that leads to it being branded in the same way. For this reason we consider that the current debt to equity ratio (50%/50%) should be maintained."

39. On 29 November 1996, the BHPB board approved revised capital expenditure on the HBI project from A$1,550,000,000 to $1,673,600,000. The approved increase was $123.6m. Consistent with the advice received from Corporate Taxation, on 30 January 1997 the directors of BHPDRI resolved to allot 370 million $1 shares to BHPM Holdings.

40. As the general ledger for the loans from Finance to BHPDRI records, Finance advanced funds to BHPDRI which, together with the subscriptions of capital, were used progressively to pay expenses incurred by BHPDRI in the development and construction of the HBI plant. In addition, the general ledger trial balance recording the loan from Finance to BHPDRI reflects that the loan was conducted in accordance with Finance's standard lending terms for inter-company loans adopted by resolution of the board of Finance on 30 November 1994 (see [21] - [23] above).

41. In August 1997, BHPB's Managing Director (Mr Prescott) asked Mr McGregor to conduct a review of the HBI project. At that time, one of the central issues raised by Mr Prescott was that, from the start of the project, not all of the risks associated with the project were understood. At the time of the review, Mr McGregor was Executive General Manager Finance for the BHPB Group as well as a director of both BHPB and Finance. The review was completed by 11 September 1997 ("the HBI Audit Report"). The HBI Audit Report attached to the memorandum from Mr McGregor is important. That report stated, inter alia, that:

  • 1. the projected NOPAT [net operating profit after tax] and ROC [return on capital] from the HBI plant per se were very modest, which was recognised at the time of the initial capital submission;
  • 2. escalation in Capex and cash operation costs (thought to be $140 per tonne) meant that the HBI project on a stand alone basis would not generate a return in excess of 1.5% to 2.5%. (This is to be compared with the fact that the Detailed Capital Submission Report in 1995 showed that the HBI Plant on a stand alone basis had a DCF rate of return of 3.5%);
  • 3. HBI was a low margin business that needed cheap gas, cheap electricity, low capital costs and low operating cost to succeed and the HBI project was challenged in relation to each of these matters.

42. At that time, the choice was to abandon the project altogether or persist with completion as economically and expeditiously as possible. In the best interests of Finance and the BHPB Group, Mr McGregor concluded that "a forward view of the project reveal[ed] that there [was] no case to be made for either abandoning the project or slowing it down [and that] the only sensible course of action [was] to complete the project as expeditiously and cheaply as possible". As a result, Mr McGregor sought approval for total capital expenditure on the HBI plant of $2,275 million plus $128 million for commissioning costs. Consistent with the McGregor recommendation, on 18 November 1997, the Chief Executive Officer of BHP Ferrous Minerals forwarded to the Managing Director of BHPB (Mr Prescott) a memorandum entitled "[HBI] Project Supplementary Authorisation" seeking additional capital expenditure of $730 million, an increase of 44% above the existing authorisation. Based on an incremental cost to complete the project of $550 million, the memorandum reported that (1) the incremental NPV (nominal at 12.5%) was expected to be $888 million with a nominal IRR of 32.3% and (2) if the project did not proceed, the associated NPV loss was expected to be $429 million. The projected cash flows from the HBI project were set out in Attachment 1 to the "[HBI] Project Supplementary Authorisation" to be:

ATC 9501

Financial Summary 		Year 1 1998 Year 2 1999 Year 3 2000 Year 4 2001 Year 5 2002 Subsequent Years (Average)
Cash Flow A$M -948.8 -549.8 -91.8 360.5 244.7 557.1

The uncontroverted evidence was that these projected "cash flows" were calculated prior to commissioning of the project by reference to the outgoings incurred, and then, after commissioning, were calculated by deducting expected costs and the cost of replacement of capital from projected revenues. By year six, the projected cash flows were positive. A payback period of six to seven years was expected.

43. Mr McGregor's recommendation together with the supplementary capital expenditure submission was considered and accepted by the BHPB board on 27 November 1997. After the board meeting, the Managing Director of BHPB (Mr Prescott) forwarded a memorandum to the Chief Executive Officer BHP Ferrous Minerals, copied to the Executive Director Finance, on 1 December 1997 in the following terms:

"I confirm that the Board at its meeting on 27 November gave approval for completing and commissioning the Pilbara HBI project as recommended in your memo of 18 November 1997. In so doing the Board gave approval for the expenditure of an additional $730 million on the project comprising $668 million in additional capital spending and $62 million in additional capitalised pre-commissioning operating expenditure.

In implementing this approval the following imperatives apply:

  • 1. Every effort must be made to improve the commercial outcomes of the entire project.
  • 2. There is to be clear and thorough reporting of all significant developments in a timely fashion including all management action to address issues that may arise or opportunities for project outcomes to be improved.
  • 3. This reporting is to be monthly through Iron Ore's Business Reports and through appropriate comments in the Managing Director's Report, also monthly through Project Management's Business Report and quarterly (or more frequently if required) in the Business Reports presented to the Board.
  • 4. We are to pursue the proposal to sell down 15% of the project to our Japanese partners in our other iron ore businesses.
  • 5. We are to further investigate the advantages and disadvantages of iron ore feed price alternatives to the plant."

A copy of this memorandum was sent to Mr Lance Coburn who at this time was the Group General Manager, BHPM Finance. In his capacity as Group General Manager, BHPM Finance, Mr Coburn had responsibility for the financial aspects of BHPM, which included preparation of statutory accounts for most of the entities within BHPM, and responsibility to ensure compliance with BHPB Group policies and procedures in preparation of capital expenditure submissions and compliance with capital expenditure approvals.

44. On 5 December 1997, the Group General Manager BHPB Budgets and Accounting sent a note to Mr McGregor (at that time the Executive General Manager, Finance and a director of Finance) entitled "Asset Carrying Values". The note listed those assets which did not or would not provide a return of 10% or greater by May 1998 based on current book values. One of the assets listed was the HBI plant as a stand alone asset. The NPV of that operation based on book value determined on a 10% DCF basis was negative $657 million. This value did not include any benefits from the plant to be derived by the iron ore mines.

45. Construction of the HBI Plant continued throughout 1998. Two critical events occurred during the course of that year. At the end of the 1998 financial year (31 May 1998) the board of BHPB changed its accounting policy for determining the recoverable value of non-current assets from undiscounted future net cash flows to discounted cash flows using the weighted average pre-tax interest rate of the BHPB Group's long term borrowings. This change was adopted to reconcile the accounts prepared under the Australian generally

ATC 9502

accepted accounting principles ("GAAP") with those applicable under United States GAAP. As a result of this change, adjustments were made to the recoverable value of non-current assets which resulted in changes to BHPB's profit and shareholders' equity. In the case of BHPDRI, as at 31 May 1998, the carrying value of BHPDRI's non current assets was written down by $590 million. The financial effect of the write down was to reduce the carrying value of certain assets of BHPDRI by that amount and to reduce BHPDRI's profit by $377,600,000 (after tax).

46. The second event was an update on the HBI project presented to the BHPB board on 27 November 1998. By that time, construction of the plant was "largely complete" with the first briquette expected at the end of January 1999. However, there were still problems. The US scrap price had plunged to new depths and the estimated sales of briquettes would not require full plant capacity once the plant was completed and commissioned. At that time, the options were to "[c]ommission all trains on current schedule (1/99, 4/99, 5/99, 6/99) [and] Operate 1 train and others necessary to meet market" or "Defer Completion & Commissioning Module 2 [and] Commission & Operate When Market Justifies (2002?)". On 30 November 1998, the BHPB board agreed that BHP Ferrous Minerals "should complete construction of the entire plant, commission all trains on [the] current schedule and then operate only those trains necessary to meet (R&D) testing and product sales requirements".

47. Consistent with the recommendation and subsequent approval by the BHPB board, train 1 of the HBI Plant was commissioned in early January 1999. However, it was shut down after 10 days because of production difficulties associated with the reduction process to produce DRI. The production difficulties were caused by the iron ore and partly reduced material not flowing continuously through the reactor train. There were frequent, sudden flow stoppages which upset the process and any attempt to balance the heat and mass flows in the reactor. In addition, the stoppages greatly increased the rate of accretion growth which required the reactors to be cleaned every 25 rather than every 160 days. At the end of the 1999 financial year, the carrying value of the HBI plant was written down by a further $531 million after tax.

48. On 21 July 1999, a letter was sent on BHPB letterhead from Joe Czyzewski, a director of Finance, to the directors of BHPDRI in the following terms:

"[Finance] is aware that [BHPDRI] has commenced selling product and is working towards generating a viable cash flow in order to service its loans.

In the circumstances, [Finance] confirms that it does not intend for the period of twelve month's (sic) from the date of this letter, or for such shorter period as we may specify at our election, intend to seek repayment of any loan it may have with [BHPDRI] but shall keep the company's commercial performance under ongoing review.

Prior notice shall be given to you should it become necessary for [Finance] to take action in respect of any loan."

49. In March 2000, a further review of the HBI project was undertaken in response to the BHPB board's concerns about current performance of the operations and the inability of the plant to meet commissioning targets. At the BHPB board meeting on 23 March 2000, a presentation was made about the future of the HBI plant. The board resolved: (1) that trials to assess the technical adequacy and commercial viability of the HBI facility should proceed until September 2000 when the board would again review the investment; and (2) to approve additional capital expenditure of $46 million. At the same time, a review of the carrying value of the asset was to be completed by the end of April 2000.

50. The board of Finance met on 30 March 2000. After noting the decisions of the BHPB board on 23 March 2000 and that BHPDRI was indebted to Finance in the amount of $2,113,944,530, the Finance board resolved to write to the BHPDRI directors to advise them that Finance would conduct a review of the loan by engaging Ernst & Young as independent experts to report on the valuation of the loan. Pending receipt of the Ernst & Young report, the directors of Finance agreed that a provision be made against the loan in Finance's books by

ATC 9503

adopting the "worst case" scenario which indicated a negative carrying value of the loan. Further consideration of the question of interest on the loan was deferred pending receipt of the Ernst & Young report. Moreover, the directors of Finance agreed to review the provision of further loans to BHPDRI after discussions with BHPB management and to keep the BHPDRI loan under close review. On 3 April 2000, Finance informed BHPDRI of these matters.

51. As a result of Finance making provision on 31 March 2000 of a $2,174 million doubtful debt for its loan to BHPDRI, Finance was left with negative net assets in excess of $940 million. The BHBP Group Treasurer (Mr Czyzewski) was concerned that if the situation was not corrected, Finance may have been in breach of its various loan and financing arrangements. Accordingly, on 7 April 2000, he sought immediate approval for BHPB to seek an allotment of 950 million ordinary fully paid up shares in Finance (the consideration for such an allotment was to be $950 million).

52. On the same day that approval was sought for BHPB to seek allotment of 950 million shares in Finance (7 April 2000), the Chief Financial Officer of BHPB wrote to BHPDRI in the following terms:

"At its meeting on 23 and 24 March 2000 the Board of [BHPB] approved additional funding of [BHPDRI] until September 2000. [Finance] has discussed the provision of further loan funds to [BHPDRI] through the existing intercompany loan facility and advised that it is unable to fund the further approved expenditure.

The shareholder of [BHPDRI], [BHPM Holdings] has agreed to inject equity into [BHPDRI] with a total issue price of $150 million. This equity injection will be completed immediately. [BHPB] has agreed to subscribe for equity in [BHPM Holdings] as may be necessary to enable [BHPM Holdings] to meet the equity injection into [BHPDRI]."

53. Approval for BHPB to seek an allotment of 950 million shares in Finance was provided and, on 11 April 2000, the directors of Finance resolved to allot 950 million ordinary fully paid $1.00 shares to BHPB.

54. At the same time, BHPB Accounting and Reporting made changes to the loan account between Finance and BHPDRI on 10 April in the following ways:

"The current loan account between [Finance] and [BHPDRI] (account number 23700011) will be 'frozen' at the 31 March 2000 closing balance, including capitalised interest yet to be booked to that date (Note: there have been no transactions since 1 April 2000).

To facilitate the day to day cash transactions of [BHPDRI], an intercompany loan account between [BHPB] and [BHPDRI] has been established and should be used from today. The account number is 23700012 and is a standard [BHPB] short term, interest free loan.

Following the $150 million equity injection, this intercompany loan account must be maintained as an asset loan (debit balance) in [BHPDRI's] accounts as the funding of HBI operations is via equity not the loan facility. A request for further equity funding will be necessary if required. …"

(emphasis in original).

55. After providing their preliminary views in April 2000, Ernst & Young tendered their report on the valuation of the BHPDRI loan receivable to the directors of Finance on 3 May 2000. Ernst & Young concluded that the value of the HBI plant did not exceed $346 million and had a nil value if the plant was closed. The report was considered by the directors of Finance at a meeting of the board held on the day the report was issued, 3 May 2000. The directors resolved that:

  • "1) the Directors having made due inquiries and on the basis of the advice and conclusions given to Directors by the independent expert, have formed the view that the amount of $1,845,833,281 lent to [BHPDRI] is irrecoverable and bad and be written-off as bad;
  • 2)
    • (a) the entries be made in the accounts of [Finance] to record the write-off of the irrecoverable amount pursuant to Resolution 1 forthwith; and
    • (b) the provision continue to be carried against the balance of the loan not written-off being $346,000,000.00.

  • ATC 9504

    3) subject to the above accounting entries being completed, [BHPDRI] be subsequently notified that due to the poor financial condition of [BHPDRI] it would not be economically prudent to expend additional monies in taking proceedings to recover any or all of the said monies once they have been written off …"

The Directors went on to note that interest on the loan would continue to be capitalised on the balance not written off and provided as doubtful.

56. On 10 May 2000, Finance wrote to both the directors of BHPDRI and to BHPDRI advising of the loan write off of $1,845,833,281 against the outstanding principal and interest of $2,191,833,281 and that following the write off, the directors of Finance had resolved not to take any further action to recover the debt written off as it appeared practically irrecoverable but that Finance reserved the right to recover the balance. The letter went on to state that Finance did not intend to seek repayment of the balance for the period up to 15 June 2001.

57. On 18 May 2000, the directors of BHPDRI resolved to allot 150 million $1 shares to BHPM Holdings. On 31 May 2000, BHPDRI wrote off the balance of its HBI investment in the sum of $794 million after tax. Towards the middle of 2000, things appeared to improve after significant further capital expenditure expended to alter the process conditions within the reactor essentially resolved the initial problems.

58. At 30 June 2000, BHPB applied Div 245 of Schedule 2C of the 1936 Act to cancel the losses and Finance claimed the bad debt deductions under s 25-35(1)(b) of the 1997 Act.

59. On 24 May 2001, the BHPDRI directors resolved to allot an additional 45 million $1 shares to BHPM Holdings.

60. Over 2003 and 2004, levels of production at the HBI plant increased. However, the HBI plant continued to be plagued by upsets in production. By May 2004, operations had been suspended following an accident which resulted in the death of one employee and serious injury to three others. After a detailed review of options for the plant, BHPB announced on 24 August 2005 that it would permanently close the HBI Plant.

BHPTM

61. BHPTM (known as Mineral Deposits Pty Ltd until 14 July 1995) had a long history of mining titanium minerals. It had titanium minerals mining operations and a processing plant in New South Wales. BHPTM also held a mining lease over a large resource of titanium minerals (predominantly ilmenite) at Beenup in Western Australia.

62. In November 1994, the proposal was to develop ilmenite mining and processing facilities at Beenup in Western Australia and to purchase an interest in an existing ilmenite smelting facility at Tyssedal in Norway. The proposal was to mine the ore body (containing ilmenite and other heavy minerals) at Beenup and to truck the heavy mineral products to the Port of Bunbury for export to the Tyssedal Facility and other users. The mine and associated processing facilities were to be conducted by BHPTM.

63. On 15 November 1994, the Chief Executive Officer of BHPM (Mr JK Ellis) sought approval, by way of submission, from the BHPB board for the expenditure of A$222.6 million for the purpose of developing the mining and processing facilities at Beenup in Western Australia and the purchase of an interest in the existing Tinfos ilmenite smelting facility at Tyssedal in Norway. The capital expenditure submission recorded, inter alia, the nominal IRR of the proposal was 19.1% (15.2% real) with a payback period of 6.7 years.

64. On 21 November 1994, the Corporate Treasurer (Mr Zimmerman) sent a memorandum to the Executive General Manager Finance analysing the BHPM capital expenditure proposal. At that time, the "major technical risks" were that there was "no mineral sands experience of dredging to 45 metres depth and that the deposit [had] a high slimes content". The BHPB board approved capital expenditure of $222,600,000 for the BHPTM project at Beenup on 24 November 1994.

65.

ATC 9505

The general ledger trial balance recording the loan from Finance to BHPTM reflects that the loan was conducted in accordance with Finance's standard lending terms for inter-company loans adopted by resolution of the board of Finance on 30 November 1994 (see [21] - [23] above). As a result of those loan terms and in particular cll (b) and (h) of the standard loan terms, each loan was for a five (5) month term.

66. On 5 July 1995, a two year letter of comfort was provided by BHPB to the directors of BHPTM. So far as is relevant, the letter stated:

  • " 1. Existing Debts

    [BHPB] undertakes to your company to ensure that your company is provided with sufficient funds to pay those debts which your company has elected to incur before the date of this undertaking, if your company is called upon to pay those debts and if, but for this letter, your company would now be insolvent.

  • 2. Future Debts

    [BHPB] undertakes to your company to ensure that your company is provided with sufficient funds to pay debts which your company elects to incur after the date of this undertaking, if your company is called upon to pay those debts, and if, but for this letter, your company would be insolvent at the time when it incurs the debt or as a consequence of incurring the debt.

  • 3. Meaning of 'Debts'

    Notwithstanding anything in Clause 1, 2 or 5, this letter applies only to debts which your company incurs or has incurred:

    • (a) in the normal course of its operations;
    • (b) in accordance with all relevant approved operating and capital budgets, business plans, policies and procedures of [BHPB] or otherwise with the express or implied approval of [BHPB].

  • 4. Discharge by Payment or Subscription

    Without limiting any other right of [BHPB], [BHPB] may completely discharge its obligations under this letter in respect of any debt by subscribing for shares issued by your company with a nominal value equal to the amount of the debt or by paying the amount of the debt to your company at any time.

  • 5. Termination
    • 5.1 Upon the earlier of:
      • (a) the expiry of two (2) years from the date of this letter; or
      • (b) your company receiving from [BHPB] a notice which states that this letter is revoked,

        this letter shall forthwith cease to be of effect, except in respect of debts which exist before that time.

    …

  • 6. Benefit of letter: Reliance

    This letter is for your benefit of your company and its directors only, and is not to be relied upon by any other person."

67. The loan funds provided by Finance were used to fund the continuing development of the Beenup mine from 1995. Production at the mine commenced on 13 January 1997. At that time, BHPTM already had entered into a long term contract to supply ilmenite to a BHPB joint venture in Norway ("the Norwegian Contract").

68. On 17 July 1997, a second letter of comfort was provided by BHPB to the directors of BHPTM. Again, so far as is relevant, the letter was largely in the same terms as the first letter of comfort (see [66] above) but for cl 5.1(a) which stated "the expiry of one year from the date of this letter". The board minutes of BHPTM resolved that "on the basis of" the 17 July 1997 letter of comfort, there were reasonable grounds to believe that BHPTM would be able to pay its debts as and when they fell due and the board authorised the directors to sign the relevant statement to be provided under s 301 of the Corporations Law.

69. By late 1997, BHPTM's Beenup mine had experienced significant operational difficulties. The material being mined at Beenup was much harder than expected. Further complications had arisen in disposing of and storing the tailings from the mining operations.

70. By the end of the 1998 financial year (31 May 1998), the project was continuing to encounter serious difficulties and, as a result, was not meeting its contractual commitments to

ATC 9506

supply titanium minerals to customers. Two steps were taken by BHPTM. First, BHPTM declared force majeure under the terms of the Norwegian Contract and secondly, following a review of the carrying value of assets undertaken as part of the preparation of BHPTM's financial statements for the 1998 year (ending 31 May 1998), on 18 June 1998 Mr McGregor (as Executive General Manager Finance) recommended to the BHPB board that it approve writing down the carrying value of the Beenup assets by $99 million (after tax) on the assumption that an economically feasible solution would be developed to overcome the operational difficulties at the mine. As noted earlier (see [45] above), on 31 May 1998, the BHPB Group changed its accounting policy for determining the carrying value of assets.

71. On 9 July 1998, a third letter of comfort was provided by BHPB to the directors of BHPTM. But for the date, the letter was in the same terms as the second letter of comfort (see [68] above). The board minutes of BHPTM again resolved "on the basis of" the 9 July 1998 letter of comfort that there were reasonable grounds to believe that BHPTM would be able to pay its debts as and when they fell due and the board authorised the directors to sign the relevant statement to be provided under s 301 of the Corporations Law.

72. Between May and November 1998, further work continued on the Beenup mine particularly in relation to the issue of disposal of the tailings. Throughout this period, the board of BHPB continued to approve and support the operations. In December 1998, a parallel process examining "exit possibilities" commenced.

73. The carrying value of the Beenup assets was again reconsidered during the preparation of the half yearly accounts for the period ended 30 November 1998. Following consideration of a memorandum prepared by Mr Jim Hall (the Group General Manager BHPB Budgets & Accounting) to the Executive Director Finance dated 3 December 1998, the audit committee of BHPB resolved at a meeting on 17 December 1998 that the carrying value of the Beenup assets be retained at $114 million. The memorandum recorded:

  • 1. at 31 May 1998, the carrying value of the Beenup assets was written down by $150 million (pre tax) to $134 million because of technical and other operational problems;
  • 2. between 31 May and 30 November 1998, significant progress had been made on a tailings disposal solution but the work was approximately 4 months behind plan;
  • 3. the carrying value for the half year November 1998 was fundamentally unchanged from May 1998 and again assumed an economically feasible technical solution to the technical and other operational problems;
  • 4. at the BHPB board meeting on 27 November 1998, a quarterly review of the Beenup project was presented to the board at which time the board agreed to continue with operations and in parallel to examine exit options, including by sale, merger or closure;
  • 5. the exit options and valuations were to be formalised by 31 May 1999 and if the closure option was adopted, then in addition to considering the carrying value, the BHPB accounts would need to include allowance for rehabilitation and site closure costs, breach of contract claims from customers and other costs.

74. Technical difficulties, however, continued to affect the mine and, in February 1999, a decision was made to close the plant and write off the balance of the carrying value of the investment. On 26 February 1999, BHPB issued a press release announcing the closure of the mine in the following terms:

"The decision follows an extensive study into technical problems caused by the high clay content of the Beenup orebody which had impacted on the management of tailings and the mine's ability to reach satisfactory levels of production.

President [BHPTM], Mr CE (Colin) Smith said the Company had directed considerable engineering and technical resources at resolving the problems at Beenup over a 12 month period. "After significant effort, it just wasn't possible to find a feasible solution that would allow the operations to continue. … there comes a time when a

ATC 9507

company has to made hard decisions on a project such as this. That time has come. We have taken the engineering and technical research as far as we can.

Mr Smith said [BHPB] had looked for a buyer with access to different technology and alternative business objectives for Beenup, but it had become apparent in recent days that this would not be possible. The search included major titanium mineral producers and processors around the world.

[BHPB] is committed to continuing to manage and effectively address all environmental issues at the site. A detailed decommissioning and minesite rehabilitation plan is being prepared …

Costs of the write-off of the current book value of the Beenup assets, site rehabilitation and mine closure are expected to be approximately $150 million after tax."

(emphasis added)

75. Operations at the plant ceased on 16 April 1999. After the mine closed, the directors of BHPTM conducted a review of options available to the company and considered the means by which BHPTM might have been able to service its loan with Finance. That review continued at least from May until August 1999.

76. On 31 May 1999, Finance provided approximately $62 million to BHPTM to enable it to repay an overdraft it had with the ANZ bank.

77. On 8 July 1999, a fourth letter of comfort was provided by BHPB to the directors of BHPTM. Again, so far as is relevant, the letter was largely in the same terms as the second letter of comfort (see [68] above) but for the addition of the words "[i]t does not and is not intended to impose any contractual or legal obligations on [BHPB] in respect of any other person nor bind it to any particular requirement or course of action" to the end of the letter. Before that letter of comfort was considered by the directors of BHPTM, the Group Treasurer (Mr J Czyzewski) informed the directors of BHPTM by letter dated 9 July 1999 that:

"I note that the Directors are expecting to have the benefit of a Letter of Comfort from its parent, [BHPB], in the same form as the attached draft.

[Finance] confirms that it will not demand payment of its loan to the company pending a complete review of the company's future operations, including current proposals to transfer a commercial Group operation into the company.

[Finance] shall review its position in six months time or earlier as warranted in the circumstances.

[Finance] shall advise the directors prior to taking any action in respect of its loan following the review."

78. At a meeting held on 19 July 1999, the directors of BHPTM tabled the annual accounts for the 1999 year and after referring to the 8 July 1999 letter of comfort undertaking "(on a conditional basis) to provide sufficient funds to the Company to enable it to pay debts which the Company elects to incur", the board was of the opinion "there were reasonable grounds to believe that [BHPTM] would be able to pay its debts as and when they fell due" and authorised the directors to sign the relevant statements to be provided under the Corporations Law.

79. BHPTM completed its review of options by early August 1999. At a meeting of directors of BHPTM on 18 August 1999 (chaired by Mr Coburn) the directors considered the options for meeting the existing and ongoing obligations of BHPTM. The minutes record what transpired at that meeting in the following terms:

"The outcome of recent discussions with the owners of certain profitable mining operations regarding proposals for the transfer of assets into [BHPTM] to strengthen its balance sheet, and as a result, to assist with the servicing of the [Finance] debt, was discussed. It was noted that the discussions under consideration had produced no agreement and will not be pursued.

It was agreed that no other options for improving the liquidity of [BHPTM] were apparent and it was therefore necessary to consider the means of meeting the company's existing and future obligations, in particular, the loan payable to [Finance].

ATC 9508

[Finance] had provided an undertaking not to call its loan until a review of the reorganisation opportunities had occurred. [Finance] has now requested the company to provide details of this review on Friday 20 August 1999. It was agreed that Mr Coburn make the presentation to the board of [Finance].

Finally, the directors examined the balance sheet of the company to ascertain the likely shortfall on realisation of the company's assets to meet existing obligations in the event that a demand for payment may issue from [Finance]. The directors are currently relying upon the terms of the comfort letter that was provided by the parent, [BHPB], on 8 July 1999. …"

80. On 20 August 1999, two events occurred. First, BHPTM (Mr Coburn) sent a letter to Finance concerning the future operations of BHPTM. The letter stated:

"BHPTM has been closely reviewing certain options for the transfer of a profitable mining operation into the company to bolster its balance sheet, and as a corollary, to introduce some means of servicing its loan from [Finance] over an extended period, thus avoiding an event of default.

The discussions with other Group entities concerning these proposals have ended without agreement as the options under consideration were not feasible. In view of this, the prospects of expanding the company's activities to assist with the servicing and repayment of its debt to [Finance] are now, in all likelihood, non-existent.

The directors are presently reviewing the company's balance sheet to assess its ability to meet existing and ongoing obligations. Should [Finance] call [on] its loan in the immediate future, the directors believe that [Finance] would realise little more than the amount of $11.5 million that BHPTM currently has on deposit with [Finance]."

81. That letter, together with a presentation on the financial position of BHPTM from Mr Coburn, was considered at a meeting of directors of Finance held on 20 August 1999. By that date, Mr McGregor had taken leave of absence pending his imminent retirement and the directors attending the meeting were Mr Czyzewski (the Corporate Treasurer) and Messrs HE Rose and BJ Skahill. BHPTM's financial position was summarised as follows:

  • "1. YEM '99 financials poor


    • Nopat [Net Operating Profit After Tax] Loss $13 million
      [before abnormals]    
    • Ebit [Earnings Before Interest and Tax] Loss $25 million
      [before abnormals]    

  • 2. Beenup operations closed in February 1999
  • 3. Write-offs [after tax] as follows:
    • YEM '98 $99 million
    • YEM '99 $154 million
  • 4. Review undertaken - As per letter from [BHPB] dated 9th July'99.
  • 5. Transfer to another mining operations not feasible.
  • 6. Claim against company for non-performance of supply contract - Approx $49m.
  • 7. With the exception of some land which may realise a $2-$3 million above book value, all assets in the attached balance sheet are believed to be at realisable value.
  • 8. Any future proceeds will be used to satisfy priority claims.
  • 9. The prospects of servicing or repaying the loan from [Finance] are non-existent."

82. That same day, 20 August 1999, the Vice President Group Accounting & Reporting, Mr J Hall, forwarded a memorandum to Mr Chip Goodyear concerning the loan from Finance to BHPTM. A copy of the memorandum was provided to Mr Czyzewski, the Corporate Treasurer and a director of Finance. After setting out the problems faced by BHPTM and the fact that the directors of BHPTM had advised Finance of the outcome of the recent review, the memorandum continued:

"Therefore, the Directors of [Finance] are proposing to write-down the majority of the

ATC 9509

loan to [BHPTM] of $336 million to its realisable value, having regard to the borrowing company's financial position and outlook. It is likely the Company will eventually be liquidated following satisfaction of its commercial obligations. The write-down will be disclosed in the accounts of [Finance] as a bad debt.

In order to reflect this in the accounts of the affected companies, a number of actions are recommended. [BHPB] will revoke the Letter of Comfort provided to [BHPTM] on 8 July 1999 and to create a new, but limited, Deed of Support to the extent of future external debts only including any obligations pertaining to the Beenup Project imposed on the Company under the Mining Agreement with the State Government of Western Australia.

The new Deed of Support should provide the Directors of [BHPTM] with greater security, as it will be legally enforceable. Notwithstanding this, the deed will permit the undertaking to be revoked at the discretion of [BHPB], but without limiting the comfort for any trading obligation incurred up to the date of the termination. [BHPB] does not propose, however, to support internal funding obligations under these revised arrangements.

…

It is confirmed that as the Deed of Support does not extend [BHPB's] existing exposure to the Beenup Project, or other activities of [BHPTM], no approval is required from the Board or the Managing Director. Furthermore, the proposed level of support, up to US$100 million is within your existing authority.

In order to commence these formal arrangements it is necessary to revoke the Letter of Comfort and enter into the Deed of Support.

Your approval is sought for the following:

  • • [BHPB] to advise [BHPTM] that the Letter of Comfort dated 8 July 1999 is to be revoked forthwith;
  • • A new limited undertaking will be provided by means of a binding Deed of Support with the Directors of [BHPTM] and [BHPTM]. In this regard refer to the memorandum to you from Legal Counsel (Peter Ablett). If acceptable, please sign the Deed on page 4 and have your signature witnessed.
  • • Letter dated 23 August 1999 to the Directors of [BHPTM] stating that the Letter of Comfort is to be revoked with effect from Monday, 23 August 1999 and a proposal to enter into a Deed of Support. This letter can be signed on behalf of [BHPB] by the Group Treasurer."

83. During the morning of 23 August 1999, BHPB informed the Directors of BHPTM in writing that it intended to revoke the letter of comfort of 8 July 1999 and that it proposed a new arrangement by way of a Deed of Support be entered into by the two companies which would be legally enforceable and provide the Directors of BHPTM with greater security. A draft of the Deed was attached. The letter went on to state that revocation of the letter of comfort would take effect upon execution of the Deed of Support.

84. At 11.15 am on 23 August 1999, the Directors of BHPTM (Messrs Coburn, March, CE Smith and WB Smith) met. The meeting lasted half an hour. The minutes of the meeting record that after Mr Coburn explained the outcome of his presentation to the board of Finance, Mr Coburn:

  • 1. tabled the letter from BHPB of 23 August 1999 notifying of its intention to revoke the letter of comfort of 8 July 1999 and that, in substitution, BHPB proposed to enter into a new "comfort undertaking" with BHPTM in the form of a Deed of Support which subsumed the letter of comfort;
  • 2. explained that there existed some doubt as to the enforceability of the undertaking provided in the letter of comfort of 8 July 1999 whereas the Deed offered greater security as it would be legally enforceable; and
  • 3. recommended that the offer from BHPB be accepted.

85. The minutes record that the legal ramifications of entering into the Deed and the impact on directors' responsibilities were then discussed. After agreeing to review the trading position of BHPTM later in that day, the

ATC 9510

directors resolved that each of them would sign the Deed of Support and affix the company seal to the Deed. The Deed of Support was executed and bears the date "23 August 1999".

86. That was not all that happened on 23 August. At 12 noon, 15 minutes after the meeting of directors of BHPTM concluded, and one assumes after the Deed of Support had been executed, the directors of Finance met and resolved to call for payment of the BHPTM loan of $339,216,146.22 set off against the deposit of $11,593,237.88 and in the event that there was a failure to repay the balance, to write off the balance outstanding of $310,881,702.40. Consistent with that resolution, a letter was sent by Mr Czyzewski for and on behalf of Finance to Mr Coburn as a director of BHPTM in the following terms:

"We refer to our letter of 9 July 1999 wherein [Finance] gave an undertaking that it would not call its loan whilst the company reviewed its future options which included the proposed transfer of a profitable mining operation into the company to bolster its balance sheet and to introduce a source of ongoing funds which would assist with the servicing of the loan. You advised [Finance] at a meeting on 20 August 1999 that the review has now been completed and that it was decided that it was not appropriate to pursue the options under consideration.

We have also been advised that the letter of comfort dated 8 July 1999 provided by [BHPB] to BHPTM has now been cancelled. This in combination with the results of our assessment of the financial position of BHPTM indicates to us that a material adverse change has occurred in the general financial condition of BHPTM which could materially effect (sic) its ability to perform its loan obligations.

We advise that the loan facility is hereby cancelled and we now declare the loan and all interest accrued thereon amounting to $339,216,416.22 forthwith due and payable. Please remit these funds immediately."

87. Of course, repayment of the whole of the outstanding balance of the loan was not going to occur. But for the amount on deposit, there were no funds to remit. Later that same day, BHPTM informed Finance of that fact in writing. Two remaining steps were then taken on 23 August 1999 to complete the arrangements. Finance told BHPTM of the write off and the set off against the amount on deposit and the directors of BHPTM resolved to record both the set off and the write off in the accounts of BHPTM. That is what occurred.

Bad debt claims

88. Against that factual background, I turn to consider whether those parts of the debts written off by Finance in the 2000 year (see [2] above] were each allowable as a bad debt deduction.

Legislation

89. Section 25-35 of the 1997 Act provides:

  • "(1) You can deduct a debt (or part of a debt) that you write off as bad in the income year if:
    • (a) it was included in your assessable income for the income year or for an earlier income year; or
    • (b) it is in respect of money that you lent in the ordinary course of your * business of lending money.

    …

    Special rules affecting deductions under this section

  • (5) The rules described in the table may affect your entitlement to deductions under this section, or may result in a deduction being reversed.

    Provisions of the [1997 Act] are identified in normal text. The other provisions, in bold , are provisions of the [1936 Act].

    Rules affecting deductions for bad debts
    Item For the rules about this situation: See:
      …  
    3 A deduction under this section is reduced if the debt is forgiven and the debtor and creditor are companies under common ownership and agree for the creditor to forgo the deduction to a specified extent. section 245-90 of Schedule 2C
    4 …"  

    ATC 9511

    (emphasis added).

Section 25-35(1)(b)

90. Two questions arise for consideration. First, whether Finance was in the business of lending money (s 25-35(1)(b)) and, if so, whether each loan was made in the ordinary course of that business and secondly, whether the debt due by BHPTM was bad when written off. The second issue is not relevant to the BHPDRI loan. The Commissioner accepts that part of the debt due by BHPDRI to Finance and written off by Finance in the 2000 year was bad.

Finance in the business of lending money?

91. Finance contends that it was, in the relevant years of income, in the business of lending money. The Commissioner does not agree. He concedes the evidence establishes that since at least the early 1980's:

  • 1. Finance did enter into borrowing transactions with third parties (see [13] above);
  • 2. Finance borrowed substantial sums of money from those third parties at commercial rates of interest; and
  • 3. Finance on lent those monies to related entities to fund both operational activity and new projects at a higher rate of interest (see [24] above) thereby earning substantial profits on which it paid income tax (see [24] above).

However, the Commissioner contends that Finance has not established that its activities amount to the carrying on of a business of lending money. In particular, the Commissioner contends that the evidence does not establish that the activities of lending which in fact existed (see Schedule "A") were activities of Finance and not the activities of BHPB. Put another way, the Commissioner contends that there was no evidence or insufficient evidence that Finance exercised a sufficiently independent corporate mind in respect of the lending activities recorded in its books and records for Finance to be carrying on a business of lending money: see, for example,
Levin & Co Ltd v Inland Revenue Commissioner (NZ) [1963] NZLR 801, 838-839.

92. The question whether the business being carried on by Finance was the business of lending money is a question of fact and characterisation:
Consolidated Press Holdings Ltd v Federal Commissioner of Taxation 98 ATC 5009; (1998) 88 FCR 151, 168-169,
Brookton Co-operative Society Ltd v Federal Commissioner of Taxation 81 ATC 4346; (1981) 147 CLR 441, 469 and
Ferguson v Commissioner of Taxation 79 ATC 4261; (1979) 26 ALR 307, 319-320. The essence of a business of "lending money" is not confined. As Ryan J said in
Ashwick (Qld) No 127 Pty Ltd v Commissioner of Taxation [2008] FCA 853 at [4], the expression "engaged in a business of lending money" "in the relevant provisions of the [1936 Act] and the [1997 Act] has a wide general application, capable of describing activities as diverse as those of a small pawnbroker with no treasury activities and those of a major national or international banking institution with a complex treasury, perhaps much more sophisticated and intricate than anything which the evidence suggests was engaged in or contemplated by [the relevant entity in the Ashwick litigation]".

93. Moreover, as Mason, Aickin and Wilson JJ said in
AVCO Financial Services Ltd v Federal Commissioner of Taxation 82 ATC 4246; (1982) 150 CLR 510, 527 in connection with the finance company at issue in that case:

"The essence of the business of a finance company … is the borrowing and lending of money, the rates of interest payable on money lent being significantly higher than the rates payable on the money borrowed, for it is from the difference in the interest rates that the company generates its profit, after making provision for bad debts. There is therefore an important and material difference between borrowing by a finance company in the ordinary course of its

ATC 9512

business and borrowing by a manufacturing or trading company. In general the finance company's borrowings provide money which it turns over at a profit. Borrowing otherwise than for on-lending or for the repayment of funds borrowed for on-lending, that is, borrowing undertaken for capital rather than revenue purposes, as in [
Commercial and General Acceptance Limited v The Commissioner of Taxation of the Commonwealth of Australia (1977) 137 CLR 373], is an exception to the general rule. On the other hand, borrowing by a manufacturing or trading company is often undertaken to strengthen the capital or profit-earning structure of the company. A finance company usually borrows in order to increase its working capital which is then turned over at a profit; the manufacturing or trading company frequently borrows to strengthen its permanent capital."

94. Finance contends that the concessions made by the Commissioner about the activities of Finance (see [91] above) are, themselves, sufficient to conclude that Finance is in the business of "lending money". I agree. However, the Commissioner contends that notwithstanding that on its face Finance was in the business of lending money, one should nevertheless conclude that Finance was not carrying on such a business because "Finance did not make its own decisions with respect to borrowing" and "the evidence [did] not establish that Finance exercised its corporate mind to make decisions about borrowing, particular lending activities, or any of the other activities which might be expected to have been involved in the carrying on of a systematic and organised activity sensibly able to be characterised as a business of lending money".

95. That contention raises a number of questions about the separate existence of a corporate entity and the relationship between a parent and its subsidiaries.

96. First, does the evidence of its books and records tendered by Finance gives rise to a presumption of regularity or independent existence? This is so in most, if not all, common law jurisdictions: see, eg,
Commissioner of Taxation v Bivona 90 ATC 4168; (1990) 21 FCR 562, 567 (citing Mason J in
Hope v Bathurst City Council (1980) 144 CLR 1, 8);
Dennis Willcox Pty Ltd v Federal Commissioner of Taxation 88 ATC 4292; (1988) 19 ATR 1122, 1126 (endorsing the opinion of Young J in
Pioneer Concrete Services Ltd v Yelnah Pty Ltd (1986) 5 NSWLR 254, 267 and stating that separate legal personality persists absent sham, a façade, a partnership between companies in a group in fact or law or the creation of a company to enable a legal or fiduciary obligation to be evaded or a fraud to be perpetrated);
Hobart Bridge Co Ltd v Federal Commissioner of Taxation (1951) 82 CLR 372, 385;
Freeman v Complex Computing Co Inc, 119 F3d 1044, 1052 (2nd Cir 1997) (stating that the corporate form itself gives rise to a presumption of corporate independence and limited liability because it is necessary to encourage business development);
American Leaf Blending Co Sdn Bhd v Director-General of Inland Revenue [1979] AC 676, 684 (stating that any gainful use of assets by a corporation is prima facie the carrying on of a business);
Brookton Co-operative Society Ltd v Federal Commissioner of Taxation 81 ATC 4346; (1981) 147 CLR 441, 469; see, eg, ss 18-21, 45A, 119, 124, 125, 1305 and 1306 of the Corporations Act (and the equivalent antecedent provisions) and s 69 of the Evidence Act 1995 (Cth). The Commissioner accepts this proposition in his written submissions. That is not surprising.

97. Secondly, in addition to the facts conceded by the Commissioner (see [91] above), the facts summarised at [9] to [16] above were not in dispute, including but not limited to the fact that BHPB incorporated Finance in 1975 "for a legitimate business purpose", namely "to carry on the business of financier in all its branches both within and outside Australia", and that Finance was registered as a financial institution and short term dealer for the purposes of the Financial Institutions Duty legislation in Victoria and New South Wales: see also Bivona 21 FCR 562, 567 and the other cases cited in [96] above.

98. What then is relied upon to displace a finding that Finance was a separate legal entity which carried on the business of lending money? As noted, the Commissioner's objection is not so much that Finance does not

ATC 9513

carry on a business but that it is the parent company (BHPB) that carries on the business of lending money and Finance does not. Put another way, that Finance was at the relevant time a "mere conduit" of its parent company, BHPB. I reject those contentions. Putting to one side whether the language of s 25-35 imposes a requirement of independent corporate mind and decision making when there exists a separate legal entity that is engaged in the business of lending money (an assumption I make in favour of the Commissioner for the purposes of considering his argument), the Commissioner's argument fails for at least two reasons. First, because that conclusion (ie that Finance was a "conduit" for its parent) "begs, not answers, the question whether the activities of [Finance] are correctly characterised as its principal business consisting of the lending of money" (Bivona 21 FCR 562, 567), and, in any event, because the submissions relied upon by the Commissioner are contrary to the facts and no less importantly, contrary to long established authority.

99. The Commissioner's argument directly raises questions about the weight or importance that should be given to the fact that the corporate boards of BHPB and Finance overlapped, that Finance relied upon the board of BHPB to approve capital expenditure on a particular project and that Finance relied upon the processes and procedures of BHPB in deciding the split between debt and equity for each project and, accordingly, the amount to be lent by Finance to the particular subsidiary with responsibility for that project. It is to those issues I now turn.

100. The mere fact that corporate boards overlap is insufficient to defeat the presumption of separate existence:
Walker v Wimborne (1976) 137 CLR 1, 3-4 (as to the fact that the companies had common directors) and 6-7; see also
Seltzer v IC Optics Ltd, 339 FSupp2d 601, 610-611 (DNJ 2004),
United States v Bestfoods, 118 SCt 1876, 1888 (1998) ("It is a well established principle [of corporate law] that directors and officers holding positions with a parent and its subsidiary can and do 'change hats' to represent the two corporations separately, despite their common ownership");
Leo v Kerr-McGee, Civ A No 93-1107(JEI), 1996 WL 254054 (D NJ, 10 May 1996) at *6 ("A significant degree of overlap between directors and officers of a parent and its subsidiary does not establish an alter ego relationship"). In fact, there is a general presumption "that the directors are wearing their 'subsidiary hats' and not their 'parent hats' when acting for the subsidiary", so dual office holding alone is not enough to establish liability: Bestfoods, 118 SCt at 1888 (quoting P Blumberg, Law of Corporate Groups: Procedural Problems in the Law of Parent and Subsidiary Corporations (1983) § 1.02.1, 12).

101. Moreover, notwithstanding what may have been said by the Full Court in
Spassked Pty Ltd v Commissioner of Taxation 2003 ATC 5099; (2003) 136 FCR 441, 470-71 about active management,
Brookton Co-operative Society Ltd v Commissioner of Taxation 81 ATC 4346; (1981) 147 CLR 441 establishes that the activities necessary to constitute a business are not onerous or extensive. In Brookton, Aickin J (at 469-70) considered that simply accepting a gift of shares and holding them until they produced dividends was enough activity to constitute a business. In the same way, lending one's own funds sourced from a third party at interest and receiving a higher rate of interest on that advance, even if directed by another to make the advance, is sufficient to constitute carrying on a business: see eg
Carapark Holdings Limited v Commissioner of Taxation (1967) 115 CLR 653 at 659. The facts in Spassked are distinguishable - in that case, the entity was interposed and, unlike Finance, did not receive interest on the loans it made. In the present case, even if Finance was acting in the BHPB Group's interest, as in
Commissioner of Taxation v E A Marr and Sons (Sales) Ltd 84 ATC 4580; (1984) 2 FCR 326, 330-31, that is sufficient for it to be carrying on a business. In that case, the Full Court held that informal leasing between parent and subsidiaries constituted carrying on of a business even where no income was derived from the transactions in question and the parent retained complete ability to control the subsidiaries' lending activities and profits.

102. Here, over an extended period, Finance not only borrowed and on lent money on numerous occasions to a variety of entities at rates of interest (which the Commissioner did not suggest were less than commercial) but did

ATC 9514

so on loan terms stipulated by Finance and where "the rates of interest payable on the money lent were significantly higher than the rates payable on the money borrowed" (see [93] above), thereby generating a substantial profit:
Commissioner of Taxation v Bivona 90 ATC 4168; (1990) 21 FCR 562, 567-9. The fact that the loans made by Finance were made to related entities is not determinative: Bivona (1990) 21 FCR 562, 569.

103. And the fact that Finance might have been or in fact was acting in the BHPB Group's interests is not unusual. In
NEAT Domestic Trading Pty Ltd v AWB Ltd (2003) 216 CLR 277, 296, McHugh, Hayne and Callinan JJ described the relationship between a parent (AWB Limited ("AWB")) and its wholly owned subsidiary (AWB (International) Limited ("AWBI")) in the following terms:

"AWBI … is a company limited by shares incorporated under the Corporations Law. To a very great extent, its powers, and the powers and obligations of its organs, are regulated by the applicable companies legislation. So, for example, at the time of the events giving rise to this appeal, its board of directors owed duties to its sole shareholder, AWB. The content of those duties was to be found in the Corporations Law (Vict) and the considerable body of judge-made law affecting directors' duties. The central duty of the board of AWBI was to observe its constitution and to pursue the interests of the company as expressed in that document. As a wholly owned subsidiary of AWB those duties would, no doubt, have required the board of AWBI to pursue the interests of its parent (and thus, its parent's shareholders) to the extent that those interests were compatible with other obligations of AWBI. In fact the interests of the two companies coincided. The constituent documents of both AWB and AWBI required that AWBI seek to maximise returns to those who sold wheat into AWB wheat marketing pools."

104. That was the position here - Finance was incorporated on 29 August 1975 as a wholly owned subsidiary of BHPB "for the purpose of borrowing funds to re-lend to Group companies" with one of its objects "to carry on the business of financier in all its branches both within and outside Australia" (see [9] above). The fact that the directors of the corporate boards overlapped and that Finance relied upon the staff and processes of the BHPB Group (for which it paid a fee) does not detract from the inevitable finding that Finance was not a sham, was not a mere conduit, was in a business and that business was lending money in the sense described by the High Court in
AVCO Financial Services Ltd v Federal Commissioner of Taxation 82 ATC 4246; (1982) 150 CLR 510, 527 (see [93] above) and
Coles Myer Finance Ltd v Federal Commissioner of Taxation 93 ATC 4214; (1993) 176 CLR 640, 663-664. See also
Federal Commissioner of Taxation v Unilever Australia Securities Limited 95 ATC 4117; (1995) 56 FCR 152, 156 and 158. No other conclusion is open: see, eg,
Mills v Mills (1938) 60 CLR 150, 164-165;
Walker v Wimborne (1976) 137 CLR 1, 6-7 and
Briggs v James Hardie & Co Pty Ltd (1989) 16 NSWLR 549, 577.

BHPDRI and BHPTM loans made in the ordinary course of Finance's business of lending money?

105. The Commissioner contends that even if Finance's business was that of lending money, there was insufficient evidence to assess whether each of the loans to BHPDRI or BHPTM was made in the ordinary course of that business. I also reject that contention.

106. The loan account provided by Finance to each of BHPDRI and BHPTM was conducted in accordance with Finance's standard lending terms for inter-company loans adopted by resolution of the board of Finance on 30 November 1994 (see [21] to [23], [40] and [65] above). As a result of those loan terms, particularly cll (b) and (h) of the standard loan terms, each loan was for a five (5) month term. As the summary of facts demonstrates (BHPDRI at [26] to [60], BHPTM at [61] to [87], Finance at [91] to [104] and [107] to [118] below), each loan was made in the ordinary course of Finance's business of lending money.

107. Consistent with the principles in
Fairway Estates Pty Ltd v Federal Commissioner of Taxation 70 ATC 4061; (1970) 123 CLR 153 and
Franklin's Selfserve Pty Ltd v Federal Commissioner of Taxation 70 ATC 4079

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; (1970) 125 CLR 52, each loan was not an instance of lending for an extraneous purpose. Finance made the loans to both BHPDRI and BHPTM to advance its own purpose of profit-making by lending. It was not Finance's business to make decisions about debt and equity. Finance's business was to borrow and lend money following the making of such decisions by others. But for the lending by Finance, Finance would not have derived the substantial interest income and profits from 1986 to 2002 (see [24] above). The "hiccough" in the 2000 year is the subject of these proceedings. The fact that out of 17 years of continued and successful borrowing and lending money, two projects "failed" in one year (the 2000 year the subject of these proceedings) does not and cannot convert these loans to loans for an extraneous purpose or being other than in the ordinary course of that business.

108. Moreover, for the reasons set out in section (i) above (see [91] to [104] above), the circumstances in which each loan was made are not the same as or analogous to those considered by the High Court in
Franklin's Selfserve Pty Ltd v Federal Commissioner of Taxation 70 ATC 4079; (1970) 125 CLR 52, especially at 66-67. Here, it cannot be said that each loan was an isolated transaction of a very special character undertaken by Finance at the behest of BHPB. Each investment was considered by the BHPB board in accordance with usual practice (see [18] and [29] (generally), [26] to [32] in relation to BHPDRI and [62] to [64] in relation to BHPTM), and once approved by the BHPB board, the funding of that investment was determined in accordance with BHPB's Accounting Policy Manual (see [19] above). That portion of the investment funded by Finance was subject to Finance's own standard terms and conditions which provided for Finance to generate a profit on the amount lent to the borrowing entity in each case (see [21] above). The projects partly funded by Finance's "advances" (whether to BHPDRI or BHPTM) were the subject of ongoing reviews at regular intervals by the board of BHPB and Finance (in the case of BHPDRI see [36] to [60] and in the case of BHPTM see [69] to [82]).

BHPDRI

109. In relation to the BHPDRI loan, the Commissioner contends that the circumstances of that loan differed in important respects from the features which were characteristic of Finance's business of lending money and that its conduct was "curiously uncommercial behaviour". The characteristics relied upon by the Commissioner included:

  • 1. that ownership of the HBI project was divided between different legal entities, and the loan from Finance to BHPDRI was not in the ordinary course of Finance's business because BHPDRI was the loss carrier in relation to the HBI project and it cannot have been Finance's ordinary practice to finance projects by unsecured loans to an entity which was expected from the outset to make a loss;
  • 2. the HBI project only satisfied the various BHPB policies relating to capital expenditure because components of the project other than the HBI plant were profitable;
  • 3. the projected returns from the HBI plant worsened over time; for example, the NPV of the HBI plant in isolation was negative $657 million at the end of September 1997 (see [44] above).

110. The facts surrounding the HBI project establish, contrary to the Commissioner's contentions, that each loan to BHPDRI was not an isolated transaction of a very special character undertaken by Finance at the behest of BHPB. Capital expenditure authorisation on the HBI project was sought in accordance with the BHPM Capital Procedures Manual (see [28] and [29] above).

111. The initial and subsequent capital expenditure authorisation submissions and reviews outlined the expected returns of the project (see [28] and [30] in 1995, [36] to [39] in late 1996, [41] to [42] in 1997, [46] in late 1998, [49] and [50] in March 2000). At the outset, in 1995, the project had a payback period of 5 years. In September 1997, after the completion of a detailed review by Mr McGregor, the conclusion was that there was no case to abandon or slow down the project and that the only sensible course of action was to complete the project as expeditiously and

ATC 9516

cheaply as possible (see [41] above). In fact, the project then was still forecasted to generate average net annual future cash flows of $557.1 million from year 6 (see [42] above). Finally, the decision to close the HBI plant came years after the debt was written off, after production had in fact increased and as a result, at least in part, of unforeseen events or events beyond the control of BHPDRI (see, for example, [60]).

112. On the question of repayment of the BHPDRI loan, the Commissioner contended that at the time of the initial investment in the HBI project, the return on investment by BHPDRI itself was insufficient for BHPDRI to repay to Finance any loan made to it in accordance with Finance's standard inter-company loans (see [21]-[22] above). In support of that contention, the Commissioner referred to two documents (1) the initial capital expenditure authorisation submission of 16 June 1995 (see [28] above) and (2) the McGregor memorandum dated 11 September 1997 (see [41] and [42] above).

113. The memorandum prepared on 16 June 1995 by the Chief Executive Officer of BHPM (Mr JK Ellis) that sought initial approval for capital expenditure by BHPB on the HBI plant demonstrated that HBI sales were modest in relation to anticipated returns on the project as a whole (for example, $43 million net operating profit after tax in 2004). However, not only is the value non-negative, repayment of the BHPDRI loan from Finance is supported by a number of facts. First, at each point the decision to invest (or invest further) was taken on the basis of the return on the project as a whole given the facts which existed at the time of each review: see [28] and [30] in 1995, [36] to [39] in late 1996, [41] to [42] in 1997, [46] in late 1998, [49] and [50] in March 2000. Further, the Commissioner's contention that anticipated cash flows would be insufficient to make repayments was calculated using discounted cash flows rather than actual dollars. In the context of a repayment of a loan, such an approach does not provide a complete answer to the question of whether an entity can repay a loan in real dollars in years to come. Moreover, selection of BHPDRI as the project entity, consistent with Section 21.19 of the BHPB Accounting Policy Manual (see [19] above), was considered together with the appropriate debt funding levels for such a project (see [31] above). Those two issues (the entity and the debt funding levels) were interrelated and considered on the basis that BHPDRI would ultimately make a profit and, until it did, the anticipated "substantial pool of tax losses generated in [BHPDRI" would provide BHPB with the ability to offset income and tax payments in other parts of the BHPB group (see [38] above). Finally, it was the uncontested evidence of Finance that had the HBI project achieved the anticipated returns, there would have been a funds flow in the form of additional equity by way of redeemable preference shares or, as stated by Mr McGregor, it was "…usual that the BHPB group entities which contributed to overall profit were rewarded or compensated for such contribution, for example by way of an internal cash flow adjustment".

114. The HBI project posed a series of difficult decisions throughout the life of the investment (for example, these difficulties were the subject of the review conducted by Mr McGregor in 1997 (see [41] and [111] above)). The evidence establishes that throughout the life of the project decisions were made on the basis of obtaining the best possible return in circumstances that were not ideal: see [36] to [39] in late 1996, [41] to [42] in 1997, [46] in late 1998, [49] and [50] in March 2000. To provide a simplistic example, where an investor makes a $10 million investment, and that investment goes bad, the investor is often faced with limited options. Cut their losses by abandoning the project and recouping little, if any, return on the investment or, depending upon the circumstances, invest further funds in the hope of generating a greater return on the total funds expended. The course of action adopted will depend upon many factors including but not limited to availability of investment capital, project risk and the period of repayment. It is a calculation undertaken by investors and lenders on a daily basis. This is what occurred here - a series of reasonable and diligent decisions with respect to the HBI project and BHPDRI. The circumstances existing at the date of each review and the analysis of the facts and circumstances relating to each of the decisions is recorded: see [36] to [39] in late 1996, [41] to [42] in 1997, [46] in late 1998, [49] and [50] in March 2000.

115.

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To adopt the language used by the Menzies J in Franklin's Selfserve (at 66), each of the advances by Finance to BHPDRI was not "isolated", was not of a "very special character" and did not arise external to the "taxpayer carrying on a business as a money lender".

BHPTM

116. Similarly, it cannot be said that "each" loan to BHPTM was an isolated transaction of a very special character undertaken by Finance at the behest of BHPB. As the summary of the facts reveals (see [61] to [87] above), the BHPB board continued to approve and support the operations and although the project experienced difficulties, those difficulties were sought to be addressed at significant cost with the expectation that those difficulties would be resolved or with BHPTM considering other options (such as looking for a buyer with access to different technology and alternative business objectives for Beenup (see [74]) or the "transfer of assets into [BHPTM] to strengthen its balance sheet, and as a result, to assist with the servicing of the [Finance] debt" (see [79] above)). It was only in August 1999 that the directors of BHPTM reached the point that there were "no other options for improving the liquidity of [BHPTM]" (see [79] above). It was only on 20 August 1999, and no earlier, the directors of BHPTM advised Finance in writing of the future operations of BHPTM (see [80] above). The directors of Finance then met and after considering the letter of 20 August 1999 together with a presentation on the financial position of BHPTM from Mr Coburn (see [81] above) Finance took the steps that it did on 23 August 1999 (see [86] to [87] above). Finance's last advance to BHPTM was 30 June 1999.

117. The Commissioner also contends that if the advances to BHPTM were made in accordance with BHPB Group decisions and processes, then the advances were inconsistent with the BHPB Group's decisions and policies about appropriate debt / equity ratios. In support of that contention, the Commissioner referred to the fact that BHPTM's debt / equity ratio was negative until 2001 and that BHPTM had negative shareholders' funds for many years requiring letters of comfort to enable it to operate as a going concern. The contention that the advances to BHPTM were inconsistent with the BHPB Group's decisions and policies about appropriate debt / equity ratios was based on the assumption that it was BHPB's usual practice to ensure that shareholder's funds of BHPB Group entities remained positive and that the debt / equity ratio would be no more than 80%. In fact, the evidence did not establish either assumption. As BHPM Taxation stated in 1996 when considering BHPDRI (see [38] above), "…the selection of a debt to equity ratio is a matter of choice" and "[t]he section should therefore take into account the intended purpose of the company". The facts and circumstances relevant to determining the appropriate levels will vary depending on the industry and the purpose of the company. The position BHPTM found itself in was unusual. As noted above (see [116]), steps were taken to address the difficulties it faced and to reverse the financial position of BHPTM. The fact is that none of those steps was successful.

118. In these circumstances, it cannot be said that "each" loan to BHPDRI and BHPTM was an isolated transaction of a very special character undertaken by Finance at the behest of BHPB.

BHPTM loan bad?

119. Next, the Commissioner contends that the principal and interest owing in respect of the BHPTM loan in the 2000 year was not a bad debt when most of it was written off on 29 August 1999.

120. The facts relevant to this issue are set out at [61] to [87] above. Two questions arise. First, when and how do you assess whether a debt is bad and secondly, was the BHPTM debt bad when it was written off?

121. As the High Court said in
G E Crane Sales Pty Ltd v Federal Commissioner of Taxation 71 ATC 4268; (1971) 126 CLR 177, 194-195 with reference to the term bad debt, "[a] sum of money comes within the ordinary meaning of those words if it is owed to the taxpayer by some other person but is reasonably regarded as irrecoverable". The process of writing off "as bad debts amounts which are owing but which cannot be recovered" was described by Menzies J in the same case (at 187) as "a sensible commercial exercise and one to which taxation significance is naturally

ATC 9518

enough given". Put simply, whether a debt is "bad" is a question of fact:
Dinshaw v Commissioner of Income Tax (Bombay) (1934) 50 TLR 527, 528.

122. Finance submitted that in determining whether the BHPTM debt was bad when it was written off (23 August 1999), the Court is limited to considering the facts which existed at the time of write off - in particular, a time when the 1999 comfort letter had been revoked. On the other hand, the Commissioner contends that the BHPTM debt could not then reasonably be regarded as irrecoverable and therefore bad because:

  • 1. had Finance demanded repayment before the 1999 comfort letter was revoked, it could reasonably be expected that BHPB would honour the undertaking made in the 1999 comfort letter to BHPTM and its directors;
  • 2. the BHPTM debt remained recoverable under the earlier comfort letters which were not affected by the revocation of the 1999 comfort letter; and
  • 3. if the BHPTM debt became irrecoverable (except to the extent of $11.5 million on deposit), it did so by Finance's own conduct in making or acquiescing in an arrangement with BHPB by which Finance demanded repayment of the BHPTM debt only after the 1999 comfort letter was revoked.

123. In rejecting the Commissioner's contentions, it is unnecessary to articulate some general or universal rule about whether, in assessing if a debt was bad at the time it was written off, one is limited to the facts and matters at the time of write off or what Finance described as the "taxable facts": see
Bailey v Federal Commissioner of Taxation 77 ATC 4096; (1977) 136 CLR 214, 217 and
Federal Commissioner of Taxation v Orica Ltd 98 ATC 4494; (1998) 194 CLR 500, 531 and
Federal Coke Co Pty Ltd v Federal Commissioner of Taxation 77 ATC 4255; (1977) 34 FLR 375, 387. In my view, there can be no general or universal rule because the facts relevant to the question of whether or not a debt was bad when it was written off will vary from one case to another.

124. In this case, it is necessary to bear steadily in mind that when Finance called for payment of the BHPTM debt on 23 August 1999, it was not paid and it was irrecoverable but for the deposit. To ask as the Commissioner's submissions require whether in other circumstances or at an earlier time the BHPTM debt might have been recoverable is beside the point. In any event, the matters referred to by the Commissioner do not factually or legally support the contention that at the time the BHPTM debt was written off it was not bad. The fundamental propositions which underpin the contentions of the Commissioner (see [122] above) are that:

  • 1. the 1999 comfort letter was enforceable and operated in favour of Finance as a form of guarantee; and
  • 2. despite revocation of the 1999 comfort letter, the earlier comfort letters either continued in existence or were revived.

125. Both those contentions require consideration of the form and effect of the comfort letters.

126. First, each of the comfort letters was binding as between BHPTM and its parent but created no rights in favour of Finance. The cases which have considered the enforceability of comfort letters appear to fall into one of two groups. The first common fact pattern is: (1) subsidiary seeks debt financing; (2) outside bank (not in-house financier) agrees to lend provided that comfort letter is given by parent; (3) letter is given to the bank; (4) subsidiary fails to pay; and (5) bank sues parent. Those cases, taken together, establish the proposition that letters in terms not dissimilar to the comfort letters in issue in these proceedings are equivalent to a guarantee as between the party to whom the letter is addressed and the issuing party:
Newtronics Pty Ltd (rec & mgrs appd) (in liq) v Atco Controls Pty Ltd [2008] VSC 566 at [7], [9]-[11] and [13];
Gate Gourmet Australia Pty Ltd (in liq) v Gate Gourmet Holding AG [2004] NSWSC 149 and the authorities referred to. These cases say nothing about whether the comfort letters created any rights in favour of Finance sufficient to have precluded it from writing off the BHPTM debt as bad. Each comfort letter expressly stated that it was not to be relied upon by any other person (see [66], [68], [71] and [77] above). But even in the absence of such a statement, what "rights" did Finance have as a result of the

ATC 9519

comfort letters that precluded it from writing off the debt as bad? The Commissioner did not identify any "rights" Finance had against BHPTM to compel BHPTM to take action against BHPB under or as a result of the comfort letters. If, as the Commissioner appeared to contend, they were "rights" Finance had to take legal action against BHPTM to recover the debt, those rights existed independent of the comfort letters. Such an action might have resulted in the winding up of BHPTM. If that were to occur, a liquidator of BHPTM would take whatever legal action (if any) he or she considered appropriate having obtained advice in relation to the circumstances which then existed. Whether that legal action would have included action against BHPB under the comfort letters (if those letters had been still in force at a relevant time) rises no higher than an educated guess.

127. The second common fact pattern in the comfort letter cases is: (1) entity enters into transaction or publishes financial statements; (2) independent financial or legal adviser issues a comfort letter to the entity stating that it is satisfied that the financials are correct, preconditions for transaction are met or something along those lines; (3) letter contains disclaimer saying it is for the benefit of the addressee only and should not be relied upon by anyone else; (4) third party enters into transaction or purchases shares; and (5) it turns out preconditions are not met or financials were false; and (6) third party sues the independent adviser, claiming estoppel or tortious misrepresentation: see eg
Dakota Bank v Eiesland, 645 NW2d 177 (Minn App 2002) and the authorities cited. The issue in those cases is usually whether, notwithstanding the disclaimer, the third party can make out a claim of reasonable reliance.

128. This second group of cases also support Finance's contention that the comfort letters created no rights in favour of Finance. First, the letters were not written for the purpose of the Finance-BHPTM loan; rather, they were written for the purposes of the directors being able to sign the accounts. That is to say, there is no evidence that Finance relied on or was induced by the comfort letters in making the loans to BHPTM. That proposition was never put by the Commissioner in cross examination to Mr McGregor, a director of Finance. In fact, during the course of his cross examination, Counsel for the Commissioner asked Mr McGregor in the context of the debt owed by BHPTM to Finance "And as a director of Finance, you didn't consider demanding repayment from [BHPTM] while there was a letter of comfort from [BHPB]? His response was "I - not that I recall. I am not sure of the relevance of the letter of comfort." Counsel for the Commissioner did not identify any conduct which suggested, let alone established, that Finance relied on or was induced by the comfort letters in making any advance to BHPTM. Accordingly, it is not necessary to consider whether any reliance was reasonable and whether that should be determined as a question of fact or a question of law:
Dakota Bank v Eiesland, 645 NW2d 177, 182 (Minn App 2002).

129. Secondly, even if Finance had an arguable case for establishing reasonable reliance on the comfort letters, the Commissioner as a fourth party to the letter cannot rely on it as establishing rights in favour of Finance sufficient to have required Finance to have concluded that the debt was not bad. Until there is a curial declaration, any promissory estoppel claim by Finance was only a mere equity: see
Daly v Sydney Stock Exchange Ltd (1986) 160 CLR 371, 387-90, Brennan J stating that a recipient of property pursuant to a contract the product of fraudulent misrepresentation does not become a constructive trustee until the transferor elects to avoid the contract (approved in
Lonrho Plc v Fayed (No 2) [1992] 1 WLR 1, 11-12) ;
Bristol and West Building Society v Mothew [1998] Ch 1, 23, Millett LJ stating that for tracing purposes equitable title does not revest retrospectively on rescission to cause application of trust property that was then proper to be treated as a breach of trust;
Giumelli v Giumelli (1999) 196 CLR 101, 112, in a joint judgment, Gleeson CJ, McHugh, Gummow and Callinan JJ stating that a remedial constructive trust does not necessarily carry with it all of the fiduciary obligations of an express trust and can simply be akin to an order to convey identified property back to another.

130.

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The Commissioner's technical case must therefore amount to the proposition that before Finance was entitled to write the BHPTM debt off as bad, (1) it had to actually bring an estoppel claim and test its validity; or (2) establish that a mere equity (ie a chose in action for estoppel without a curial declaration recognizing the equitable interest) held by Finance in the property of BHPB to the extent of the BHPTM debt was sufficient to prevent Finance from writing that debt off. Both propositions should be rejected. In the absence of other evidence (as was the position here), a contract (in this case the comfort letters) can rise no higher than its respective terms: see eg
Agricultural and Rural Finance Pty Ltd v Gardiner (2008) 251 ALR 322, 346.

131. The Commissioner's non-technical case (ie had Finance really wanted the money, BHPB would have paid) is equally difficult to accept. If such a submission were to be accepted, the effect would be that the form of all transactions between wholly-owned subsidiaries would be disregarded for tax purposes. That is because in any situation involving two wholly owned subsidiaries where one subsidiary cannot on its own meet an obligation to the other, the parent (assuming it is not itself insolvent) always can and will enable a subsidiary in difficulties to meet the obligation, regardless of any legal obligation on its part, provided that there is a commercial reason (ie benefit to the overall group) to do so. In that sense, therefore, no debt between two wholly owned subsidiaries is ever bad because, in the words of Mr Coburn, the parent will always "sort it out". I reject that contention.

132. Having formed the view that none of the comfort letters created any rights in favour of Finance sufficient to have precluded it from writing off the BHPTM debt as bad, it is strictly unnecessary to go on to consider whether despite the revocation of the 1999 comfort letter, the other comfort letters either continued in existence or revived. It is sufficient for present purposes to note that each comfort letter was for a specified term (one or two years) or until it was revoked. Upon the happening of either of those events, each letter forthwith ceased to be of effect "except in respect of debts which exist[ed] before that time". It is at least arguable that the terms of each comfort letter supplanted the terms of the earlier comfort letter in relation to "existing debts" and any earlier comfort letter became irrelevant.

133. Finally, when the 1999 comfort letter was revoked, it was replaced by a Deed of Support (see [82] - [86] above. Again, that Deed did not create any rights in favour of Finance that precluded Finance from writing off the BHPTM debt as bad. Significantly, the Deed provided (in cl 6) that BHPTM and the directors of BHPTM (defined as the "Beneficiaries") released and discharged BHPB from any claim they might have, or might have had, against BHPB arising out of or connected with the 1999 comfort letter.

134. For those reasons, the existence of none of the comfort letters precluded Finance from writing off the BHPTM debt as bad.

Conclusions on s 25-35(1)(b)

135. Each of the BHPDRI and BHPTM debts written off by Finance in the 2000 year was deductible under s 25-35(1)(b):

  • 1. Finance was in the business of lending money;
  • 2. Each loan was made in the ordinary course of that business;
  • 3. It was not in dispute that that part of the BHPDRI loan written off was bad when it was written off and, in my view, that part of the BHPTM loan written off, was bad.

Alternative arguments

136. In the alternative, Finance also relied upon: (1) s 8-1 of the 1997 Act in relation to the whole of the bad debt deductions; and (2) s 25-35(1)(a) of the 1997 Act to claim interest on both the BHPDRI loan and the BHPTM loan which it had previously brought to account as assessable income and which was written off in the 2000 year. Given the views I have formed about Finance's entitlement to claim the bad debts written off in the 2000 year as allowable deductions under s 25-35(1)(b), it is unnecessary to consider either of these alternate claims.

137. However, in the expectation that this proceeding will be the subject of appeal, it is appropriate that I say something about each of them.

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s 8-1

138. It was common ground that the application of s 8-1 does not require a finding that Finance's business was that of lending money. It is sufficient if the loss was incurred in carrying on of a business for the purpose of producing assessable income:
Federal Commissioner of Taxation v Munro (1926) 38 CLR 153, 170. The Commissioner contended that both the BHPDRI loan and the BHPTM loan were not within the scope of s 8-1 because each was made "outside the scope of [Finance's] business" and each "was an isolated transaction of a special nature".

139. For example, in relation to the BHPDRI loan it was said that the project, as a whole, had a higher risk level than the overall risk level of the BHPB Group. I reject these contentions. First, as discussed earlier (see [106] to [115]), each loan was within the scope of Finance's business. Moreover, neither was an isolated transaction of a special nature. As noted earlier, each investment was considered by the BHPB board in accordance with usual practice (see [18], [29] and [36] above), and once approved by the BHPB board, the funding of that investment was determined in accordance with BHPB's Accounting Policy Manual (see [19] above). That portion of the investment funded by Finance was subject to Finance's own standard terms and conditions which provided for Finance to generate a profit on the amount lent to the borrowing entity in each case (see [21] and [22] above).

140. Each of the debts written off as bad was deductible because the act of lending money (subsequently written off) was for the purpose of producing assessable income for Finance:
AGC (Advances) Ltd v Federal Commissioner of Taxation 75 ATC 4057; (1975) 132 CLR 175, 197-198 and
Magna Alloys & Research Pty Ltd v Federal Commissioner of Taxation (1980) 80 ATC 4542, 4551 and 4559. Put another way, money was Finance's stock in trade and loss of that money entitled Finance to an allowable deduction for that loss:
Federal Commissioner of Taxation v Marshall & Brougham Pty Ltd 87 ATC 4522; (1987) 17 FCR 541, 552-3. Contrary to the submissions of the Commissioner, it cannot be said that only another company in the group would derive assessable income as a result of Finance providing a loan to BHPDRI and a loan to BHPTM. It was Finance that lent the money, it was Finance that charged interest at a margin over the amount it itself paid for funds it borrowed and it was Finance that included the accrued interest on the amounts it lent in its assessable income: cf
Hooker Rex Pty Ltd v Federal Commissioner of Taxation (1988) 88 ATC 4392, 4403-4404 ;
Commissioner of Taxation v E A Marr and Sons (Sales) Pty Ltd 84 ATC 4580; (1984) 2 FCR 326 and
Federal Commissioner of Taxation v Total Holdings (Aust) Pty Ltd (1979) 79 ATC 4279, 4283.

141. Finally, the Commissioner contends that if each loss was made by Finance in gaining or producing assessable income, the claimed deduction should only be allowed in part. I also reject those contentions.

BHPDRI

142. In the case of BHPDRI, the Commissioner seeks to apportion the deduction on the basis that there was no reasonable prospect of BHPDRI ever repaying the interest and principal on the funds advanced and further, because Finance continued to advance funds without reasonable prospect of repayment. Those contentions are not supported by the evidence. As the summary of facts records (see [26] to [60], [110] - [113] above), the project was the subject of approval prior to its commencement and then subject to review at regular intervals. It is not in dispute that success of the HBI plant was expected to have benefited the BHPB Group as a whole.

143. Moreover, the evidence does not support the conclusion that there was no reasonable prospect of BHPDRI repaying the interest and principal on the funds advanced at the time of the making of each advance (Marshall & Brougham(1987) 17 FCR 541, 549 per Bowen CJ) or that Finance continued to advance funds without reasonable prospect of repayment. As noted earlier, in 1995 the project had a payback period of 5 years and in 1997 the project was still forecasted to generate average net annual future cash flows of $557.1 million. The uncontroverted evidence of Mr McGregor was also important in a number of respects. First, that he was aware that the HBI project was expected to contribute to the overall BHPB

ATC 9522

Group profits and secondly, in his experience BHPB Group entities which contributed to overall profit were rewarded or compensated for such contribution by an internal cash flow adjustment. Further, not only were there capital injections (as recorded in the loan accounts) but there were also a number of reviews undertaken to assess the viability of the HBI plant. Finally, the decision to close the HBI plant came years after the debt was written off and as a result, at least in part, of events beyond the control of BHPDRI.

144. What that history reveals is that Finance initially provided funds in circumstances where capital expenditure on the project had been approved by the BHPB board and it was expected that the HBI Plant would be successful. However, that did not and does not mean that there was no reasonable prospect of BHPDRI every repaying the interest and principal on the funds advanced or that Finance continued to advance funds to BHPDRI without reasonable prospect of repayment. There is no basis for apportionment.

BHPTM

145. Further and in the alternative, the Commissioner contended that even if the loans to BHPTM commenced in circumstances where each had a sufficient nexus with the earning of income or the conduct of a business, the circumstances attending the loans changed so profoundly over time that the nexus dissolved so that only a portion of the total deductions claimed by Finance should be allowed. In support of this contention, the Commissioner relied upon the undisputed fact that the advance at the start of each 5 month term was a fresh advance and that despite:

  • 1. BHPTM having negative net assets and negative shareholders' equity at 31 May 1996, 31 May 1998 and 31 May 1999;
  • 2. by December 1997, the HBI project being overspent and there being substantial spending on items outside the original scope of the project;
  • 3. the carrying value was written down in May 1998 from $150 million to $134 million;
  • 4. the carrying value was written down to nil in February 1999,
Finance continued to permit BHPTM to draw down on its loan account for project rehabilitation and other costs as well as repayment of $62 million to the ANZ Bank even after BHPB announced that the mine would close.

146. Consistent with the authorities referred to by the Commissioner (
Fairway Estates Pty Ltd v Federal Commissioner of Taxation 70 ATC 4061; (1970) 123 CLR 153, 162 and Marshall and Brougham (1987) 17 FCR 541, 549-50), the question which arises is whether each advance was "made as part of a business of money-lending then carried on by the taxpayer". It is important to recall that in this context, the taxpayer is Finance.

147. As the summary of the facts reveals (see [61] to [87], [116] and [117] above), at the times specified by the Commissioner in [145] above (31 May 1996, 31 May 1998 and 31 May 1999), (1) the BHPB board continued to approve and support the operations; and (2) when the project experienced difficulties, either those difficulties were being addressed at significant cost with the expectation that those difficulties would be resolved or BHPTM was considering other options. Those options included looking for a buyer with access to different technology and alternative business objectives for Beenup (see [74]) and the "transfer of assets into [BHPTM] to strengthen its balance sheet, and as a result, to assist with the servicing of the [Finance] debt" (see [79] above).

148. It was August 1999 before the directors of BHPTM reached the point that there were "no other options for improving the liquidity of [BHPTM]" (see [79] above). It was at that point (specifically, 20 August 1999) that the directors of BHPTM advised Finance in writing of the future operations of BHPTM (see [80] above), the directors of Finance met and after considering the letter of 20 August 1999 together with a presentation on the financial position of BHPTM from Mr Coburn, Finance took the steps that it did on 23 August 1999 (see [86] - [87] above).

149. In those circumstances, none of the facts and matters identified by the Commissioner (see [145] above) whether taken singularly or collectively support the contention

ATC 9523

that each advance was not made as part of Finance's business of money-lending then carried on by it. Finance's business had not changed. Finance's last advance to BHPTM was 30 June 1999. At all times, Finance provided and continued to provide funding to BHPTM in circumstances where it cannot be said each advance did not have a sufficient nexus with the earning of income or the conduct of Finance's business. As Williams J said in
Tweddle v Federal Commissioner of Taxation (1942) 180 CLR 1, 7, it is not the function of the income tax Acts or of the Commissioner "to dictate to taxpayers in what business they shall engage or how to run their business profitability or economically. The Act must operate upon the result of a taxpayer's activities as it finds them. … [T]he Commissioner is not entitled to say [that a taxpayer] must close down the unprofitable business and cut his losses even if it might be better in his own interests and although it certainly would be better in the interests of the Commissioner if he did so". As in Tweddle, it is apparent that until Finance wrote off the debt as bad, Finance held a genuine belief (which it was entitled to hold) that the loan would be repaid in one of the ways outlined above. Finance was entitled, as it did, to rely upon the past success and expertise of BHPB and BHPTM.

Section 25-35(1)(a)

150. As I noted earlier, Finance also relied upon s 25-35(1)(a) to claim interest on both the BHPDRI loan and the BHPTM loan which it had previously brought to account as assessable income and which was written off in the 2000 year.

151. Each of these claims fails at the outset. They fail because an essential precondition to the operation of s 25-35(1)(a) in relation to each loan - that all or any part of the sum written off as bad in the 2000 year comprised interest - is absent. That requires some explanation.

BHPDRI Interest

152. The relevant facts are summarised at [24] above. Finance returned interest income as it accrued and not on a receipts basis. From 1996 to 2000, the total BHPDRI interest income totalled $430,338,836. That fact is not in dispute. What is in dispute is the characterisation of (1) the amounts repaid under the loan before 3 May 2000; (2) the amount of $1,845,833,281 written off as bad on 3 May 2000 and (3) the amount not written off as at 3 May 2000 of $346,000,000.

153. The answer lies in Finance's standard lending terms and, in particular, paras (f), (g) and (h) which are set out at [21] above.

154. As those standard terms provide (and what in fact happened), each amount Finance advanced was a separate loan for a five month period: cl (b) and (h). At the end of each five month period, the total of the then existing loan (principal and interest) was rolled over into one new loan: cl (g). On each "roll over", the then existing outstanding principal and interest was replaced by a new loan comprising a principal advance equal to the total amount then outstanding. The interest owing at the end of each five month period was capitalised and formed part of the principal of the new loan. The fact and existence of a "new loan" at the start of each five month period is important. What existed at the end of the previous five month period was, by agreement, replaced by a new loan comprising one amount of principal. That conclusion is reinforced by the fact that the loan account numbers 325320 and 326320 were used on alternate five month periods with the loan balance of one account being reduced to zero before the entire sum then owing was relent as principal to BHPDRI using the other loan account.

155. What occurred here was precisely that referred to by Brennan J in
Bank of New South Wales v Brown (as official liquidator of Tom the Cheap (WA) Pty Ltd (in liq)) (1983) 151 CLR 514, 546 (see also Dawson J at 554-555), namely:

"If the debt is discharged, whether by account stated, by payment or by other means, a liability which takes its place will be of a different character."

It is a novation: the annulment of one debt and the creation of a substituted debt in its place:
Scarf v Jardine (1882) 7 App Cas 345, 351 (per Lord Selborne),
Re United Railways of Havana and Regla Warehouses Ltd [1960] Ch 52, 84 and 86, affirmed in
Tomkinson v First Pennsylvania Banking and Trust Co [1961] AC 1007 and
Olsson v Dyson (1969) 120 CLR 365,

ATC 9524

388 (Windeyer J in dissent, but not on this point).

156. Contrary to the express words of Finance's standard loan terms, Finance contends that the reference to "advance" in cl (f) of the standard terms does not include capitalised interest but refers simply to principal amounts lent by Finance to BHPDRI and, therefore, capitalised interest does not form part of the principal sum advanced:
Bank of New South Wales v Brown (as official liquidator of Tom the Cheap (WA) Pty Ltd (in liq)) (1983) 151 CLR 514. Even if Finance's submission was correct (and I need not decide the issue), it provides no answer to the fact that at the end of each five month period, the DRI loan or loans of principal and interest during a five month period were replaced with a new advance of principal at the start of the next five month period. Any repayment in any five month period was, consistent with cl (f) applied to reduce, first, the opening outstanding advance and then any additional loans in that five month period in access of $50,000.

157. As a result, as at 3 May 2000 when Finance wrote off $1,845,833,281.34 of the BHPDRI debt:

  • 1. the debt related to a loan of principal of $2,014,599,808 advanced by Finance to BHPDRI on 30 November 1999 on the terms and conditions set out above (see [21] above);
  • 2. in the period from 30 November 1999 (the date of the advance) until 3 May 2000 (the date when part of the loan was written off):
    • (a) the only interest charge was a sum of $79,246,114.12 charged to the loan account on 30 April 2000 as "capitalised interest" less the sum of $16,482,163.79 of capitalised interest for April which was reversed; and
    • (b) there were no repayments;
  • 3. the total loan balance (principal and interest) outstanding was $2,191,833,281.00. In fact, the general ledger records the loan balance immediately prior to the write off as $2,173,637,557.88. The difference is attributable to an amount of capitalised interest for the period from 1 April to 3 May 2000 of $18,195,723.46 added to the loan balance on 3 May 2000 and recorded in the general ledger as being charged to the loan account after the write off.

158. The question which then arises is whether there was any interest previously brought to account as assessable income and which was written off in the 2000 year to which s 25-35(1)(a) could apply? The answer is no.

159. Consistent with the loan terms and the manner in which the BHPDRI loan was conducted, none of the capitalised interest previously brought to account as assessable income prior to 30 November 1999 was written off in the 2000 year. It had been repaid by BHPDRI or relent as principal by Finance to BHPDRI at the start of each five month rollover. Moreover, the amount written off on 3 May 2000 was, consistent with cl (f) of the loan terms, first applied to the amount of principal ($2,014,599,808) advanced by Finance to BHPDRI on 30 November 1999. None of that sum was interest. It was all principal lent by Finance to BHPDRI on 30 November 1999.

160. In those circumstances it is unnecessary to characterise all or part of the amount not written off as bad as at 3 May 2000. That task is unnecessary because an essential precondition to the operation of s 25-35(1)(a) is that the debt be written off. This part of the debt was not. Section 25-35(1)(a) does not apply to any part of the BHPDRI loan.

BHPTM interest

161. Finance's contention that s 25-35(1)(a) applies to entitle Finance to write off the sum of $310,881,702.40 in respect of the BHPTM debt also fails. As with Finance's claim in relation to the BHPDRI interest, as at the date of write off (23 August, 1999), there was no sum of interest included in Finance's taxable income which remained unpaid. On 30 June 1999, a fresh advance of $336,394,327.20 was made by Finance to BHPTM. On 23 August 1999, $310,881,702.40 of that loan was written off. Consistent with the cl (f) of Finance's standard lending terms (see [21] above), the repayment (in this case, the writing off of the loan) was applied to reduce the earliest outstanding advance - namely the advance on 30 June 1999 of $336,394,327.20. None of that amount comprised interest. In relation to the balance of the debt, it was not written off. Section

ATC 9525

25-35(1)(a) does not apply to any part of the BHPTM loan.

Part IVA apply to disallow TM bad debt deduction?

162. Finance disputes the application of Pt IVA on two bases. First, that the Commissioner has no power to seek to rely upon his s 177F determination because he did not issue an assessment or more accurately, an amended assessment, to give effect to that determination and secondly, even if he was entitled to seek to rely upon Part IVA, it does not apply. I will deal with the issues in turn.

Need an assessment to give effect to a determination under s 177F?

163. An assessment to disallow Finance's bad debt deductions (deduction of $2,156,714,984 in relation to BHPDRI loan and BHPTM loan) was issued to Finance by the Commissioner on 23 June 2005. That assessment did not give effect to a Pt IVA determination. Finance objected to the assessment. Its grounds of objection were limited to contentions that it was entitled to a deduction under s 25-35 or s 8-1 of the 1997 Act. Unsurprisingly, Finance's grounds of objection did not address Pt IVA.

164. On 8 June 2006, in the course of considering Finance's objection, the Commissioner proceeded to make a determination under s 177F(1)(b) of the 1936 Act. The Commissioner did not give effect to that determination by the issue of an amended assessment. Instead, he relied upon s 169A(3) of the Act.

165. Was the Commissioner entitled to adopt that course? In my view, contrary to the submissions of Finance, the Commissioner was entitled, in the circumstances of this case, to rely upon s 169A(3) of the 1936 Act.

165. First, the express words. Section 169A provides:

  • "(1) Where a return of income of a taxpayer of a year of income is furnished to the Commissioner (whether or not by the taxpayer), the Commissioner may, for the purposes of making an assessment in relation to the taxpayer under this Act, accept, either in whole or in part, a statement in the return of the assessable income derived by the taxpayer and of any allowable deductions or rebates to which it is claimed that the taxpayer is entitled and any other statement in the return or otherwise made by or on behalf of the taxpayer.
  • (2) Despite subsection (1), if, in a document given with a return of income of a taxpayer of a year of income and signed by or on behalf of the taxpayer, a question is raised:
    • (a) that is relevant to the liability of the taxpayer in respect of the year of income; and
    • (b) on which the taxpayer is not entitled to apply for a private ruling under Division 359 in Schedule 1 to the Taxation Administration Act 1953;

    the Commissioner must give attention to that question.

  • (3) In determining whether an assessment is correct, any determination, opinion or judgment of the Commissioner made, held or formed in connection with the consideration of an objection against the assessment shall be deemed to have been made, held or formed when the assessment was made."

167. So far as is relevant, s 169A(3) provides that "[i]n determining whether [the] assessment is correct, any determination … of the Commissioner made … in connection with the consideration of [the] objection against the assessment shall be deemed to have been made, held or formed when the assessment was made" (emphasis added). On its face, the effect of s 169A(3) is to deem the s 177F determination made by the Commissioner at the time he considered Finance's objection to have been made when the assessment was made, approximately one year earlier.

168. Finance contends that, notwithstanding those express words, the Commissioner was not entitled to rely upon s 169A(3) and was required to issue an amended assessment to give effect to the s 177F determination. In particular, Finance submitted that: (1) the "assessment" in s 169A(3) only applies to original assessments made in circumstances contemplated by s 169A(1) and did not apply to the assessment in issue in these proceedings; (2) the phrase "determination, opinion or judgment

ATC 9526

of the Commissioner" was limited to "reviewable discretions" such as those under s 99A or the former s 80A of the 1936 Act (see
Kolotex Hosiery (Australia) Pty Ltd v Federal Commissioner of Taxation 75 ATC 4028; (1975) 132 CLR 535, 539-541 and 576); and (3) the phrase "in connection with" in s 169A(3) imposes not only a temporal requirement but also a requirement that the subject matter (in the present case, Pt IVA) be raised in the assessment the Commissioner was considering at the objection stage. I reject each of these limitations.

169. As is self evident, s 169A(3) is not, in its terms, limited in any of the ways contended for by Finance. So much is conceded by Finance. It, instead, submits that such limitations should be implied by reference to the history and context of the introduction of s 169A, its interaction with Pt IVA (and, in particular, s 177G) and the general scheme of the taxing acts. None of those matters supports any of these limitations.

170. Section 169A was inserted in the 1936 Act in 1986 as part of the first stage of self assessment: Taxation Laws Amendment Bill (No 1) 1986 (Cth). At that time, it was a 'partial' self assessment system. Section 169A was "designed to facilitate 'self-assessment' of income tax returns by making it clear that the Commissioner … [may] issue an assessment solely in reliance on the information in the taxpayer's return of income": Explanatory Memorandum, Taxation Laws Amendment Bill 1986 (Cth) (at 65) ("the 1986 EM"). In that context, the 1986 EM described the then s 169A(2) (being now s 169A(3)) as a provision (at 65) that:

"will ensure that the correctness of an assessment cannot be called into question because a particular discretion has not been exercised by the Commissioner when making the assessment. The effect of the sub-section is to deem the exercise of any discretion by the Commissioner at the time of considering an objection against the assessment to have occurred at the time of making the assessment."

(emphasis added by Finance).

171. The fact that the 1986 EM refers to a "discretion" rather than the phrase "determination, opinion or judgment" found in s 169A(3) does not mean that the express words of the section are to be ignored. It is the words of the statute, not the 1986 EM which is to be construed:
Saraswati v The Queen (1991) 172 CLR 1, 22 (McHugh J); D C Pearce and R S Geddes, Statutory Interpretation in Australia (6th ed, 2006) [2.12].

172. The further basis on which Finance sought to support the purported limitations was the subsequent enactment of the "later and fuller self assessment measure, namely s 166A, which created, for the first time, a general provision for deemed assessments upon the filing of income tax returns". At the time of its enactment (Taxation Laws Amendment Act (No 5) 1989 (Cth)), the Explanatory Memorandum described s 169A(3) (at 44) in the following terms:

"Many provisions of the Principal Act give the Commissioner a discretion whether to apply a particular provision or not. Section 169A specifies that, in determining whether an assessment is correct, any determination, opinion or judgment of the Commissioner made or formed in connection with the consideration of an objection against the assessment is deemed to have been made or formed when the assessment was made. This provision preserves the Commissioner's right to exercise his discretionary powers."

(emphasis added).

173. Contrary to the submissions of Finance, the subsequent introduction of s 166A (and the Explanatory Memorandum which accompanied its enactment) do not support the implied limitations contended for by Finance. Both s 166A and 169A are in Pt IV of the 1936 Act headed "Returns and Assessments". If, at the time of the introduction of the "later and fuller self assessment measure" in s 166A, the parliamentary drafters had intended to limit the operation of s 169A in the manner contended for by Finance, you would have expected them to do so. They did not.

174. Moreover, if the limitations sought to be imposed on s 169A by Finance were adopted, counsel for Finance were unable to identify any "determination" which the Commissioner could have "made, held or formed in connection with the consideration of

ATC 9527

an objection against the assessment" to which s 169A would have applied. In other words, if Finance's construction of s 169A were adopted, it would leave the word "determination" in s 169A(3) with no work to do. Such a result is highly unlikely and provides further support to reject Finance's contentions: D C Pearce and R S Geddes, Statutory Interpretation in Australia (6th ed, 2006) [2.22].

175. Further, Finance submitted that having regard to the history and context of s 169A(3), the Court should depart from the plain words of the section: see McHugh J in
Saraswati v The Queen (1991)172 CLR 1, 21-22. As I have stated earlier, neither the history nor the context of the section supports such a conclusion.

176. Alternatively, Finance submitted that s 169A(3) should be construed as not applying at least to Pt IVA determinations. That limitation was said to arise from the language of Pt IVA itself and the decision of the Full Court of the Federal Court in Kolotex. I also reject those contentions. First, as was noted in
Commissioner of Taxation v Jackson 90 ATC 4990; (1990) 27 FCR 1, 18-19, the Commissioner after making a determination must take such action as he considers necessary to give effect to that determination. On occasion, no step may be required where, as here, the making of a determination did not have the effect of increasing the taxable income or tax payable under a previous assessment: see the Full Court of this Court in
Commissioner of Taxation v Stokes 97 ATC 4001; (1996) 72 FCR 160, 174 and
Puzey v Commissioner of Taxation 2003 ATC 4782; (2003) 131 FCR 244, 265-66.

177. In further support of the limitations contended for by Finance and identified earlier, Finance submitted if s 169A(3) applied in a case such as the present, the Commissioner would be able to circumvent the six year limitation period which existed in the relevant years in s 177G(1) of the 1936 Act: cf
Woolcombers (WA) v Commissioner of Taxation 96 ATC 4359; (1996) 66 FCR 66, 73-74. That contention ignores the express words of s 169A(3). As noted earlier, s 169A(3) provides that "[i]n determining whether an assessment is correct, any determination, opinion or judgment of the Commissioner made, held or formed in connection with the consideration of an objection against the assessment shall be deemed to have been made, held or formed when the assessment was made" (emphasis added). The assessment is the critical starting point. Absent a valid assessment, the Commissioner cannot seek to rely upon s 169A(3). If the Commissioner has not issued a valid assessment, that is the end of the analysis. If the Commissioner has issued a valid assessment (whether an original assessment or an amended assessment) within any prescribed time limits, then any "determination, opinion or judgment of the Commissioner made, held or formed in connection with the consideration of an objection against the assessment shall be deemed to have been made, held or formed when the assessment was made" (emphasis added). Section 177G is not engaged.

178. Although this issue does not arise on the facts in this case and is no longer relevant since the six year time limits for the application of Pt IVA were removed by the Tax Laws Amendment (Improvements to Self Assessment) Act (No 2) 2005 (Cth) Sch 1 Pt IV Div 3 Item 64, the construction I have adopted would have permitted the Commissioner to apply Pt IVA at the time he considered an assessment properly issued, even though the six year period had expired. Neither the scheme of the Act nor the express provisions of the 1936 Act support a contrary conclusion.

179. As the Commissioner properly conceded, if the amount specified in the s 177F determination was more than or less than the amount in the assessment under consideration by the Commissioner, the Commissioner could not seek to rely upon s 169A(3) of the 1936 Act and would have been obliged to issue an amended assessment: s 177G of the 1936 Act. That is not surprising: eg
Commissioner of Taxation v Stokes 97 ATC 4001; (1996) 72 FCR 160, 174 ;
McAndrew v Federal Commissioner of Taxation (1956) 98 CLR 263, 278 and
Woolcombers (WA) Pty Ltd v Commissioner of Taxation 96 ATC 4359; (1996) 66 FCR 66, 73 and 74. An increase or decrease in the amount included in the assessment, would require an amended assessment: See, eg, the definition of 'assessment' in s 995-1 of the 1997 Act; s 6-1

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of the 1936 Act;
Commissioner of Taxation v Stokes 97 ATC 4001; (1996) 72 FCR 160, 174 and
Commissioner of Taxation v Jackson 90 ATC 4990; (1990) 27 FCR 1, 17-18. The express words of s 177G(1) (as it existed at the time of these issues) confirms that conclusion - it prescribed the time limits by reference to "an amendment of an assessment". It did not limit the ability of the Commissioner to seek to raise other grounds to support the existing assessment.

180. That last matter, the ability of the Commissioner to seek to uphold an assessment on a ground not dealt with in his objection decision, subject to questions of appropriate particulars and notice, is well established:
Federal Commissioner of Taxation v Australian New Zealand Savings Bank Ltd 94 ATC 4844; (1994) 181 CLR 466, 479 and
Lighthouse Philatelics Pty Ltd v Commissioner of Taxation 91 ATC 4942; (1991) 32 FCR 148, 154-155. It is a fundamental premise on which the taxing acts are based for three separate but related reasons. First, the process of assessment is concerned primarily with the amount payable by the taxpayer and not the particulars which go to establish such an assessment: Lighthouse Philatelics Pty Ltd at 154-155. Secondly, the objection is not against a particular in the assessment but as s 14ZL(1) of Pt IVC of the TAA provides, against the assessment itself: Lighthouse Philatelics Pty Ltd at 154-155. Thirdly, in considering an objection, the Commissioner is not confined to the matters raised by the taxpayer in that objection but has an obligation to administer the Act and "could form the view, based on a reconsideration of the matter, that the assessment should be confirmed for reasons which he had not previously considered. [The Commissioner's] task is to ensure that the correct amount of tax is paid …": Lighthouse Philatelics Pty Ltd at 155.

181. Questions of appropriate particulars and notice are important. They are important because Finance further submitted that if s 169A(3) permitted the Commissioner to make a s 177F(1)(b) determination at the time he considered the objection, Finance would lose the absolute right to object to the issues raised in that determination: cf
Deputy Federal Commissioner of Taxation for New South Wales v Brown (1958) 100 CLR 32, 40 (per Dixon CJ);
MacCormick v Federal Commissioner of Taxation 84 ATC 4230; (1984) 158 CLR 622, 639-641. The alleged loss of the absolute right to object was said to arise from the fact that unless a court orders otherwise, a taxpayer is limited to grounds stated in the objection to which the decision relates: s 14ZZO of the TAA. There are two complete answers to that submission. First, the Commissioner has an obligation to provide appropriate particulars and notice of any grounds upon which he seeks to support an assessment (see
Bailey v Federal Commissioner of Taxation 77 ATC 4096; (1977) 136 CLR 214, 217-218 ) and secondly, consistent with that obligation, the discretion for a court to permit a taxpayer to seek to rely upon grounds not stated in the objection to which the decision relates: s 14ZZO(a) of the TAA and
Commissioner of Taxation v Jackson 90 ATC 4990; (1990) 27 FCR 1 at 18-19.

182. That is what occurred in the present case. The Commissioner provided notice and particulars of his application of Pt IVA and the Court permitted Finance to seek to raise grounds of objection relevant to Pt IVA which, of course, had not been raised in its notice of objection. Construed in the manner I have identified, s 169A does not raise any of the four relevant considerations mentioned by Hill J in the context of Pt IVA determinations in Jackson at 18-21. A taxpayer would retain a right to object (see [175] above); a taxpayer would not lose its right to elect to refer the objection decision to the AAT or the Federal Court because the determination must be made by the Commissioner "in connection with [his] consideration of an objection against the assessment"; the assessment is not in fact amended so that no issue of side stepping time limits arises; and finally, no step is taken after the objection decision as it is the objection decision which is referred to the Court or the AAT: see ss 14ZZ(a)-(c) of Pt IVC of the TAA. In Jackson, the Court was concerned with events after the objection decision. No issue of that kind arises here.

183. Finally, previous decisions of this Court have referred to s 169A(3). Although the outcome of none of the cases turned on the proper construction of s 169A(3), each court either adopted a similar construction or referred to s 169A(3) operating in the way I have

ATC 9529

described above: see
Dan v Federal Commissioner of Taxation (No 2) 2000 ATC 4350; (2000) 44 ATR 338, 351 and, on appeal,
Kordan Pty Ltd v Federal Commissioner of Taxation 2000 ATC 4812; (2000) 46 ATR 191, 198.

184. Accordingly, the Commissioner was entitled to seek to rely upon the s 177F determination. Finance's contentions to the contrary are rejected.

Part IVA apply?

185. The Commissioner contends that if the Court finds, as I have, that the BHPTM debt was bad and that the BHPTM loan was made by Finance in the ordinary course of a business of money lending or that the BHPTM claimed deduction was otherwise allowable under s 8-1, then the BHPTM claimed deduction was liable to be disallowed by the determination made pursuant to s 177F of the 1936 Act.

186. The Commissioner concedes that his Pt IVA case has a narrow compass. It only arises if by reason of the 1999 comfort letter it could reasonably be expected that the BHPTM loan was recoverable by Finance. For the reasons set out above (see [124] - [132]), even if the terms of the comfort letters are equivalent to a guarantee between BHPB and BHPTM, none of the letters (including the 1999 comfort letter) created third party rights in favour of Finance. Moreover, even if the 1999 comfort letter had not been revoked, it could not reasonably be expected that BHPB would honour the undertaking made in the 1999 comfort letter to BHPTM and its directors. As the Commissioner conceded in his written submissions, the most obvious and simple commercial solution was what transpired - the writing off of the debt by Finance. That result was not surprising. The alternatives for dealing with the failure of the BHPTM project each had their own difficulties, including legal difficulties.

187. Three possibilities were suggested by the Commissioner: (1) that BHPB would provide funds by way of equity or loan to BHPTM for repayment of BHPTM's loan from Finance; (2) Finance could have released the debt before writing it off with the result that Finance would not have been entitled to a bad debt deduction; and (3) release of the debt before and not after revocation of the 1999 comfort letter. In support of the first alternative, the Commissioner sought to rely upon draft memoranda considering such an option. In relation to the third alternative, the Commissioner contends that if the debt was released before the revocation of the 1999 comfort letter, or without the revocation of the 1999 comfort letter, then the revenue deduction could not have been claimed because the debt would not have been bad. That possibility raises again questions about the enforceability of a letter of comfort by a third party. From a tax perspective, the Commissioner contends that the second and third possibilities would both result in the inability of Finance to write the debt off as bad and a resulting loss of capital that could only be set off against capital gains or transferred to group companies for that purpose.

188. Each of these alternatives is rejected on separate grounds.

189. The first possibility suggested by the Commissioner is contrary to the way in which the BHPB Group acted and, secondly, in the circumstances in which BHPTM found itself, likely to be contrary to provisions of the Corporations Law(as it then existed) and the directors' common law duties. The undisputed evidence of Mr McGregor was that he could not recall at any point BHPB (or for that matter another BHPB Group entity) subscribing capital to a non-viable company. That is not surprising. Directors as fiduciaries owe a duty not only to act in good faith but for the benefit of the company:
Mills v Mills (1938) 60 CLR 150, 185 (per Dixon J that "[d]irectors of a company are fiduciary agents, and a power conferred upon them cannot be exercised in order to obtain some private advantage or for any purpose foreign to the power").

190. In determining whether a director has breached his or her fiduciary duty in connection with a commercial transaction, the court in
Charterbridge Corporation Ltd v Lloyds Bank Ltd [1970] Ch 62, 74 stated the question was whether "an intelligent and honest man in the position of a director of the company concerned, could, in the whole of the existing circumstances, have reasonably believed that the transactions were for the benefit of the company". That test was adopted by Cole J in

ATC 9530

Spedley Securities Ltd (in liq) v Greater Pacific Investments Pty Ltd (in liq) (1992) 30 NSWLR 185 and by Hansen J in
Farrow Finance Co Ltd (in liq) v Farrow Properties Pty Ltd (in liq) (1997) 26 ACSR 544, but questioned by the Court of Appeal of the Supreme Court of New South Wales in
Equiticorp Finance Ltd (in liq) v Bank of New Zealand (1993) 32 NSWLR 50, where the court approached the issue by asking whether the directors were acting bona fide in the best interests of the company. Regardless of which of the two tests is adopted, adapting the words of Mason J (as he was) in
Walker v Wimborne (1976) 137 CLR 1 at 6-7, neither the facts nor the tests can:

"obscure the fundamental principles that each of the companies was a separate and independent legal entity, and that it was the duty of the directors of [BHPB] to consult its interests and its interests alone in deciding [what that company should do]. In this respect it should be emphasised that the directors of a company in discharging their duty to the company must take account of the interest of its shareholders and its creditors. Any failure by the directors to take into account the interests of creditors will have adverse consequences for the company as well as for them."

191. In the present case, it could not be said that the provision of funds by BHPB or another BHPB Group member (whether by equity or loan) was in the "whole of the existing circumstances" a transaction for the benefit of the entity providing the funding or its shareholders. BHPTM was non viable. Providing further funds by way of equity was not an alternative.

192. Similarly, the third possibility was not an alternative. As the Commissioner conceded, it proceeds on the assumption that the 1999 comfort letter created rights in a third party. That contention was considered and rejected above (see [124]-[132]). As a result, even if the Commissioner's contentions that the events that took place on 23 August 1999 (see [82] to [87] above) were artificial and contrived were accepted (a matter I do not need to decide), Pt IVA of the Act would not apply because it could not be said that the debt was not bad in the absence of those steps.

193. The second possibility - that Finance could have released the debt before writing it off with the result that Finance would not have been entitled to a bad debt deduction - is a misnomer. As the High Court said in
Point v Federal Commissioner of Taxation 70 ATC 4021; (1970) 119 CLR 453, if a debt is released, there is nothing to write off. As Owen J said in Point at 458 "[t]he effect of the release of a debt is to extinguish it, to put an end to its existence and not to reduce the value of it as an asset in the form of a debt owed to the taxpayer". Acceptance of this alternative would result in a situation where notwithstanding that a company in the business of lending money lent money in the ordinary course of that business and then lost that money, it is not entitled to claim a bad debt deduction, being a deduction otherwise provided for by the Act even though none of the steps of the scheme relied upon by the Commissioner altered the fact that the money was lost in circumstances where the deduction was available. As the applicants submitted, the question of the entitlement of a taxpayer to claim a deduction for a bad debt in the current circumstances and in the absence of any allegation that but for the scheme the deduction would not have been available is a matter for the legislature, not the Commissioner. The fact that Finance chose what the Commissioner conceded was the "most obvious and simple commercial solution" - writing off the debt after it was bad and not the uncommercial step of simply forgiving the debt - does not of itself attract the application of Pt IVA.

194. For those reasons, I do not consider that Pt IVA applies in the terms contended by the Commissioner. There is little doubt that the steps in the scheme identified by the Commissioner (namely what transpired on 23 August 1999) were calculated, systematic and taken after obtaining the necessary advice. The fundamental flaw in the Commissioner's case is that the steps in the scheme did not alter the fact that the BHPTM debt was bad and was a debt that Finance was entitled to write off as bad whether the steps in the scheme identified by the Commissioner were taken or were not taken.

ATC 9531

Division 243

Introduction

195. Division 243 applies where capital allowance deductions for expenditure funded by debt (under Div 40 of the 1997 Act) have been claimed and those deductions are excessive having regard to the amount of the debt that was repaid. In those circumstances, Div 243 provides for an additional amount to be included in a taxpayer's assessable income at the termination of a limited recourse debt arrangement: s 243-10. As s 243-10 goes on to provide "[t]he reason for the adjustment is to ensure that, where [a taxpayer has] not been fully at risk in relation to an amount of expenditure, [the taxpayer does] not get a net deduction if [it fails] to pay that amount".

196. This issue concerns capital allowances claimed by BHPDRI as follows.

Year Amount
2003 $167,027,482
2004 $160,191,081
2005 $154,884,921
2006 $120,993,150

These capital allowances were claimed as deductions by BHPB as head company of the consolidated group: Pt 3-90 of the 1997 Act.

Legislation

197. Div 243 was inserted into the 1997 Act by the Taxation Laws Amendment Act (No 5) 1999. Section 243-15(1) sets out the basic conditions that must be satisfied:

This Division applies if:

  • "(a) *limited recourse debt has been used to wholly or partly finance or refinance expenditure; and
  • (b) at the time that the debt *arrangement is terminated, 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 or the *financed property."

(emphasis added).

198. Each of the italicised phrases is defined in the 1997 Act. "Limited recourse debt" is defined in s 243-20. Sub-sections (1) and (2) are relied upon by the Commissioner. They define "limited recourse debt" in the following terms:

  • "(1) 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:
    • (a) rights (including the right to money payable) in relation to any or all of the following:
      • (i) the *debt property or the use of the debt property;
      • (ii) goods produced, supplied, carried, transmitted or delivered, or services provided, by means of the debt property;
      • (iii) the loss or disposal of the whole or a part of the debt property or of the debtor's interest in the debt property;
    • (b) rights in respect of a mortgage or other security over the debt property or other property;
    • (c) rights that arise out of any *arrangement relating to the financial obligations of an end-user of the *financed property towards the debtor, and are financial obligations in relation to the financed property.
  • (2) 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 (other than assets that are indemnities or guarantees provided in relation to the debt);
    • (b) any *arrangement to which the debtor is a party;

    • ATC 9532

      (c) whether all of the assets of the debtor would be available for the purpose of the discharge of the debt (other than assets that are security for other debts of the debtor or any other entity);
    • (d) whether the debtor and creditor are dealing at *arm's length in relation to the debt.
  • …
  • (5) However, 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.
  • (6) 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.
  • (7) A *limited recourse debt is a non-arm's length limited recourse debt if the debtor and creditor do not deal with each other at arm's length in relation to the debt."

(emphasis in original).

199. "Financed property" and "debt property" are defined in s 243-30 as follows:

  • (1) 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.
  • …
  • (3) Property is the debt property if:
    • (a) it is the *financed property; or
    • (b) the property is provided as security for the debt.

    (emphasis in original).

200. Section 243-40 provides that "[t]he debtor's assessable income for the income year in which the termination occurs is to include the excess referred to in subsection 243-35(1)". It does not apply in years subsequent to the year in which the debt is terminated. Those years are dealt with in s 243-55 which is in the following terms:

  • "(1) This section applies where this Division (other than section 243- 65) has applied in relation to a debt and the debtor is entitled to a *capital allowance deduction in respect of the expenditure or the *financed property in relation to a time or period after the termination of the debt.
  • (2) The *capital allowance deduction is reduced if the amount that would have been worked out under subsection 243-35(2) would have exceeded the amount worked out under subsection 243-35(4) if the following assumptions were applied in both subsections:

    Assumptions to be applied

    • (1) That the debt was terminated at the time, or at the end of the period, referred to in subsection (1) of this section.
    • (2) That the amount unpaid at the time, or at the end of the period, is reduced by any amounts paid under a replacement debt.
    • (3) The debtor's *capital allowance deductions in respect of the expenditure or the *financed property were increased by the amount of the capital allowance deduction referred to in subsection (1) of this section.

  • (3) The deduction is to be reduced by the amount of the excess."

201. Finally, s 243-25(1) sets out the circumstances in which the debt arrangement is terminated. For present purposes, it is sufficient to note that s 243-25(1)(g) provides that a debt arrangement is terminated if the debt becomes a bad debt.

Facts

202. The relevant facts are set out above (see [26] to [60]). As noted earlier, this issue only concerns the loan from Finance to BHPDRI.

Issues

203. For Div 243 to apply, two essential elements must be established: (1) the advances made by Finance to BHPDRI which financed expenditure in respect of which BHPDRI was entitled to deduct amounts as capital allowances must be "limited recourse debt" within the meaning of ss 243-20(1) or (2) (the

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Commissioner does not rely upon sub-s (3)); and (2) that debt arrangement must have terminated: s 243-15(1)(b). The second issue (that the debt arrangement was terminated) is not in dispute.

204. As a result, the critical issue is whether the loan from Finance to BHPDRI was "limited recourse debt" within the meaning of ss 243-20(1) or (2). It is to that issue that I now turn.

Analysis

205. Limited recourse debt has been part of the repertoire of financiers for centuries. As early as 1857, the concept of limited rights of recovery by a mortgagee against a mortgagor was considered by the Courts of Exchequer:
Mathew v Blackmore (1857) 156 ER 1409. In that case, a plaintiff brought an action to recover a sum of 200l lent by him to the defendant secured by a mortgage of certain lands. The plaintiff argued that the loan involved in it a liability to pay and subjected the borrower to an action of debt and that the mortgage - a charge upon the land to secure the debt - did not affect the right of the lender to sue the borrower for the whole of the debt. Pollock CB rejected the plaintiff's argument. The Court held that:

"the lending and borrowing of money is like any other contract, and that the right of the lender and the liability of the borrower depends upon the contract between them; and that there was no reason why in the case of a loan of money the ordinary rule should not apply, viz, that where the contract is reduced to writing in order to define and give evidence of the transaction between the parties, that the writing and the writing alone should regulate their respective rights and liabilities.

… and the presence of [a] covenant whereby the defendant covenanted to pay not absolutely but only out of such monies as should come to his hands, coupled with the fact that he was a mere trustee and had no personal interest in the transaction, shewed that it was never intended to create, as between him and the plaintiff, the relation of creditor and debtor as upon a simple loan of money."

206. The distinction between recourse and limited recourse debt was succinctly explained by the Supreme Court of Canada in
McLarty v R (2008) 293 DLR (4th) 659 at [29] in the following terms:

"In the context of debt, recourse means that the creditor has a right to repayment of a loan from the borrower, not just from the collateral that secured the loan. By contrast, non-recourse or limited recourse debt limits the creditor to the recovery of specified security. The creditor is not entitled to seek repayment from the borrower should the proceeds from the disposition of the security be less than the total indebtedness."

(emphasis added).

207. As it is a question of contract, it has no prescribed form. It depends upon what the parties have agreed or, in the modern world as the following cases illustrate, the creativity of those who put together financing packages and arrangements: see by way of example,
Esanda v Burgess [1984] 2 NSWLR 139 ;
NZI Capital Corporation Pty Ltd v Child (1991) 23 NSWLR 481, 489F;
Guest v Federal Commissioner of Taxation 2007 ATC 4265; (2007) 65 ATR 815, 819 at [11];
R v New Queensland Copper Co Ltd (1917) 23 CLR 495, 496, 501-2 (where the Queensland Government advanced money to a mining company that was to be "repaid out of the profits which shall hereafter be derived by or accrue to the company from the working of the said mines" and was therefore unable to seek to recoup the debt from the assets of the company);
Federal Commissioner of Taxation v Sidney Williams (Holdings) Ltd (1957) 100 CLR 95, 115.7;
Inland Revenue Commissioners v Herdman [1969] 1 All ER 495 ;
Federal Commissioner of Taxation v Firth 2002 ATC 4346; (2002) 120 FCR 450, 468 and
Malouf v Federal Commissioner of Taxation 2008 ATC 20-023; (2008) 68 ATR 470, 477.

208. It is therefore not surprising that the drafters of Div 243 sought to define the phrase "limited recourse debt" and to define it in the way that they did. The issue is whether the loan from Finance to BHPDRI satisfied one or both of the drafters' definitions of "limited recourse debt". In my view, it did not.

ATC 9534

Section 243-20(1)

209. The terms of and the circumstances surrounding the loan from Finance to BHPDRI are not in dispute: see [26] to [60] above.

210. The focus of s 243-20(1) is, first, to identify the existence of an obligation imposed by law on an entity (defined as the debtor) to pay an amount to another entity (defined as the creditor). In the case of BHPDRI, Finance's standard terms (see [21] above) provided, in part, that:

  • "b) Loans are to be made up of such amounts and are to be advanced on such dates as are agreed orally from time to time by the borrower and [Finance]. Each initial loan and each additional loan is to be for a period not exceeding five months at which time all loans shall become immediately repayable."

(emphasis added).

The Commissioner does not dispute the existence of this obligation on BHPDRI to repay to Finance the amounts advanced to or drawn down by BHPDRI together with any interest accrued on those amounts.

211. Having identified that obligation of BHPDRI to pay an amount to Finance, s 243-20(1) then requires identification of the "rights of the creditor" (Finance) "against the debtor" (BHPDRI) "in the event of default in payment of the debt or of interest" by BHPDRI. In the case of BHPDRI, Finance's standard terms (see [21] above) were silent. Put another way, the standard terms did not address the rights of Finance against BHPDRI in the event of default directly or indirectly.

212. For that reason alone, it cannot be said that the rights of Finance against BHPDRI in the event of default were "limited wholly or predominantly" to any of the matters listed in sub-paragraphs (a) to (c) of s 243-20(1). Moreover, as a matter of contract, there is no basis for the implication of a term in the contract between Finance and BHPDRI limiting the rights of Finance wholly or predominantly to any of the matters listed in sub-paragraphs of s 243-20(1):
BP Refinery (Westernport) Pty Ltd v Shire of Hastings (1977) 180 CLR 266, 283. Those sub-paragraphs of s 243-20(1) list what might be described as the common or more usual forms of limited recourse debt including: (a) rights in relation to the debt property or use of the debt property; (b) rights in respect of a mortgage or other security over the debt property or other property; and (c) rights arising out of any arrangement relating to the financial obligations of an end user of the financial property towards the debtor. Property is "debt property" if it is the "financed property" or the property provided as security for the debt: s 243-30(3) (see [199] above). Property is "financed property" if the debt was used wholly or partly to finance or refinance expenditure "on the property" or "on the acquisition of the property", or that "results in the creation of the property or is otherwise connected with the property": s 243-30(1) (see [199] above).

213. Finance's rights in the event of default were not so limited. Finance's standard terms did not limit "wholly or predominantly" the rights of Finance against BHPDRI in the event of default to any of the matters listed in sub-paragraphs (a) to (c) of s 243-20(1). BHPDRI's obligation to Finance was unlimited except as to the amount of the debt or interest. Finance had a right to call for repayment of the principal and any interest that had accrued, to sue on the promise of repayment in the standard terms and then to prove with other unsecured creditors in the event of a winding up of BHPDRI: s 555 of the Corporations Act;
Federal Commissioner of Taxation v Linter Textiles Australia Ltd (in liq) 2005 ATC 4255; (2005) 220 CLR 592, 612-13 and
Federal Commissioner of Taxation v Macquarie Health Corporation Ltd 98 ATC 5214; (1998) 88 FCR 451, 472. An unsecured creditor has no interest in or right to specific assets: Macquarie Health Corporation at 472.

214. Contrary to the conclusion I have reached, the Commissioner contends that s 243-20(1) "aptly describes the situation which existed as between BHPDRI and Finance". Notwithstanding that the Commissioner conceded (as he had to) that:

  • 1. BHPDRI's obligations in respect of the loan from Finance were not secured either against its own assets or assets of any other entity; and
  • 2. BHPDRI's obligations in respect of the loan from Finance were not covered by guarantees, letters of comfort or assurances from any other entity; and

  • ATC 9535

    3. in the event of default in payment of the debt or interest, Finance was limited to the ordinary rights of an unsecured creditor,
the Commissioner maintained that contention on two bases.

215. First, the Commissioner contends that the noun "rights" when it first appears in s 243-20(1) must be limited to the rights in paras (a) to (c) and that the rights listed in those paragraphs need not contain any further limitation and, secondly, consistent with that construction of s 243-20(1), Finance's practical rights of recovery or recourse against BHPDRI were wholly or at least predominantly limited to BHPDRI's assets at the HBI plant at Boodarie.

216. The express words of Div 243 (and, in particular s 243-20(1)) (see [198] above) do not support the Commissioner's construction. Moreover, if the construction contended for by the Commissioner were adopted it would lead to two absurd results. First, that one would assess whether a debt was a limited recourse debt not at the time that the loan was made or relevantly varied but when a project fails and secondly, that the debt of every unsecured creditor, regardless of the contractual arrangements between the parties, would be treated as "limited recourse debt". Those results cannot be and were not the results intended by Parliament. Read as a whole, it is apparent that the definition of limited recourse debt in s 243-20(2) was intended to expand the concept beyond those recorded in contractual arrangements between a debtor and a creditor. If the Commissioner's construction were adopted then much if not all of s 243-20 would be superfluous. Parliament could have simply referred to any arrangement where a project fails and the debtor does not repay the advance. That is not what occurred.

217. If further support for that conclusion is necessary (and I consider that it is not), it is to be found in the scheme of Div 243 as a whole. As noted earlier, it applies to cancel capital allowance deductions claimed by a taxpayer and include the value of those deductions in the assessable income of the taxpayer when the relevant debt arrangement is terminated. Assessment of whether or not the Division might potentially apply to a particular arrangement should be able to be assessed at the time of the original capital allowance deduction, not simply if and when a project fails for whatever reason.

218. Moreover, even if the Commissioner's construction were adopted (and I do not adopt it), there is some doubt about the accuracy of the factual premise in the present case. Namely, that Finance's practical rights of recovery or recourse against BHPDRI were wholly or at least predominantly limited to BHPDRI's assets at the HBI plant at Boodarie. A list of the property of BHPDRI was tendered in evidence and included licences and intellectual property. It was by no means clear that all of that property was located at or connected with the plant at Boodarie.

Financed property / debt property

219. Before leaving s 243-20(1) of the 1997 Act, it is necessary to turn to consider the concept of "financed property" in s 243-20(1)(c). As noted above (see [197] - [199] and [212]), it is a defined term. Property is "debt property" if it is "financed property" and property is "financed property" "if the expenditure referred to in s 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": s 243-30. What is the "expenditure" to which s 243-15(1)(a) is referring and what is the "property" to which s 243-30 is referring?

220. The answer to the first question is straightforward. "Expenditure" appears twice in s 243-15(1) in subsections (a) and (c). Those subsections direct attention to two matters. First, whether limited recourse debt has been used to wholly or partly finance or refinance expenditure (sub-s (a)) and, if so, whether the debtor can deduct an amount as a capital allowance (under Div 40) in respect of that expenditure or the financed property (sub-s (c)). Having regard to the views that I have formed about the absence of limited recourse debt (see [205] to [218] above), there can be no "financed property". 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

ATC 9536

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: see ss 14ZZO(b) of the TAA;
Federal Commissioner of Taxation v Dalco 90 ATC 4088; (1990) 168 CLR 614 ;
Australian and New Zealand Savings Bank Ltd v Federal Commissioner of Taxation (1992) 92 ATC 4630. That conclusion requires some explanation.

221. The applicants do not dispute that the quantum of capital expenditure on the assets of BHPDRI was recorded in the books of account of BHPDRI and totals approximately $2.16 billion for the period from 1 June 1995 to 30 June 2000.. However, it is also common ground that that total is somewhat misleading because it includes amounts capitalised for accounting purposes that were not the subject of a capital allowance under Div 40 and does not include amounts which gave rise to capital allowances under Div 40 but which were not capitalised for accounting purposes. The difficulty faced by the applicants in the present case is that the property of BHPDRI acquired by BHPDRI during the period from 1 June 1995 to 30 June 2000 was funded by the loan from Finance and from subscriptions of equity. The applicants submitted that because the property was acquired from "multiple funding sources" it was necessary to compare the change in debt funding of the company during the period in which the expenditure on that property was incurred with the amount of that expenditure. The flaw in the contention is exposed by the applicants' submission that:

"Where the funding available to [BHPDRI] in a particular month exceeded the capital expenditure, it cannot be concluded that the expenditure was funded by debt if there were other sources of funding that were sufficient to meet the expenditure. An example of this arises in June, July and August 1995. In those months capitalised expenditure totalled $18,774,979. At that time, [BHPDRI] had available to it $20,000,000 share capital, and the only other expenses [BHPDRI] incurred in that period totalled $162,901. … None of the assets acquired by this expenditure was debt property because it cannot be concluded that any of that expenditure was financed by debt, limited recourse or otherwise."

222. One only has to state the proposition to realise the flaws in it. First, there was no and could be no direct correlation between debt funding and expenditure on a month to month basis. Funds could have been supplied in one month from one source and used months if not years later. Moreover, the total capital expenditure recorded in BHPDRI's books of accounts (subject of course to the difficulties identified earlier) was in excess of $2 billion. The applicants do not and cannot dispute that the total BHPDRI - Finance debt by the 2000 year had reached in excess of $2.1 billion. At the same time, the total of the other funding sources (whether by equity contributions or otherwise) did not exceed $500 million. Thirdly, contrary to the applicants' submissions, s 243-15(1)(a) requires that the debt be used to "wholly or partly" finance or refinance the expenditure. And, fourthly, the concept of expenditure and property is itself expanded in s 243-30(1) which provides 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".

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 of 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

ATC 9537

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 finance or refinance expenditure (sub-s (a)) and that BHPDRI did deduct an amount as a capital allowance (under Div 40) in respect of some of that expenditure or the financed property: ss 243-15(1)(a), (1)(c). On no view is it possible for those amounts to be quantified with any precision.

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. I can only suspect that the applicants did not undertake that or a similar exercise in the present case because such an exercise was not only expensive but would have inevitably lead to the conclusion that the debt funding had been used to wholly or partly finance or refinance expenditure and that BHPDRI did deduct an amount as a capital allowance (under Div 40) in respect of some of that expenditure or the financed property: ss 243-15(1)(a), (1)(c).

Section 243-20(2)

225. Alternatively, the Commissioner relies upon s 243-20(2) of the 1997 Act. BHPB conceded that s 243-20(2) extends the definition of "limited recourse debt" (see [198] above).

226. The language of s 243-20(2) is important and should be restated. It builds on subsection (1). It expands the category of obligations imposed by law on a debtor that will constitute limited recourse debt under sub-s (1) where:

"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)."

(emphasis added).

227. In reaching this conclusion, the section provides that regard is to be given to:

  • "(a) the assets of the debtor (other than assets that are indemnities or guarantees provided in relation to the debt);
  • (b) any *arrangement to which the debtor is a party;
  • (c) whether all of the assets of the debtor would be available for the purpose of the discharge of the debt (other than assets that are security for other debts of the debtor or any other entity);
  • (d) whether the debtor and creditor are dealing at *arm's length in relation to the debt."

228. Subsection (2) is clearly intended to catch those debts which bear no existing legal limitation of the kind specified in subsection (1) but where "it is reasonable to conclude that the rights" in the event of default are "capable" of being limited to those rights specified in sub-s (1). As the applicants submitted, subsection (2) is intended to catch those arrangements which have the capacity to bring about the limitation described in sub-s (1). The form of that capacity is, unsurprisingly, broad and extends, for example, to "any *arrangement to which the debtor is a party". It is an objective test. Whether the capacity of the kind described exists is, of course, a question of fact to be resolved having regard to the matters listed in paragraphs (a) to (d) of sub-s (2). As the earlier analysis of the cases dealing with limited recourse debts demonstrates there is no and can be no prescribed form for such arrangements.

229. However, I do not consider that s 243-20(2) adopted or incorporated a test of economic equivalence (such as that adopted in Div 974 of the 1997 Act). That was the substance if not the form of the Commissioner's submissions - that the section necessitates an assessment of whether more than 50% of the property owned by the debtor is related to property acquired with the relevant loan proceeds. If that were the correct approach (which I reject) the result would be that funding arrangements at the start of a business would be limited recourse within Div 243 and would then fall in or out of the division depending on whether the venture was a success or a failure. The terms of the funding arrangements

ATC 9538

(whether limited in the sense of sub-s (1) or considered more broadly under sub-s (2)) would simply be irrelevant. That is not consistent with the express words of the section. If the drafters had intended the issue to be approached in that manner, they would have said so. They did not.

230. Moreover, the express words of sub-s (2) are themselves inconsistent with a test of economic equivalence. Under sub-s (2), one of the matters to consider in deciding whether the specified limitation is "capable" of being limited in the manner described is "whether all of the assets of the debtor would be available for the purpose of the discharge of the debt": s 243-20(2)(c). In my view, that matter is not a factor or pointer in favour of the section adopting or incorporating a test of economic equivalence. On the contrary, consistent with sub-s (1) and the evident purpose of the legislature to seek to define "limited recourse debt", it is to be inferred that where all of the assets of the debtor are available for the purpose of the discharge of the debt (other than assets that are security for other debts of the debtor or any other entity) that would be a factor supporting the conclusion that the rights of the creditor against the debtor in the event of default were not capable of being limited in the manner specified.

231. The interaction between Div 243 and Div 245 provides further support for the rejection of the proposition that s 243-20(2) adopted or incorporated a test of economic equivalence. Div 245 in Schedule 2C of the 1936 Act was inserted in the tax legislation to address a "structural weakness": Second Reading Speech to the Taxation Laws Amendment Act (No 2) 1996. Prior to the introduction of Div 245, on forgiveness of a debt a creditor was entitled to a bad debt deduction or a capital loss and the debtor would continue to be entitled to deduct losses accumulated before the debt was terminated and to claim capital allowance deductions for expenditure funded by the forgiven debt. In other words, both the debtor and the creditor enjoyed a deduction for the same economic loss in relation to a bad debt. That "weakness" was addressed by Div 245. In fact, in the present case, BHPDRI applied Div 245 when it lodged its returns to the bad debt written off by Finance.

232. On the other hand, Div 243 (introduced some three years later) is not concerned with or directed to the economic benefit to a taxpayer if a debt is forgiven. Div 243 is directed to the specific case where a taxpayer is not personally at risk in relation to borrowed funds used to finance an item of capital. In general terms, the measures were introduced to address not a case of double deductions for the same debt (by two different taxpayers) but the situation where a taxpayer obtained deductions greater than the total amount outlaid by that taxpayer in relation to capital expenditure under hire purchase or limited recourse debt arrangements primarily in cases where the balance of an outstanding debt that had financed the expenditure was not paid and the financier could only recover a specific asset on termination of the finance arrangement: paras 2.6-2.9 of the Explanatory Memorandum to Taxation Laws Amendment Bill (No 5) 1999 (Cth).

Conclusions about Div 243

233. As these reasons for decision demonstrate, Div 243 has no application to BHPDRI's debt with Finance. The preconditions to the Division applying set out in s 243-15(1) are not satisfied. Limited recourse debt was not used to wholly or partly finance or refinance expenditure.

Additional tax

234. As noted earlier (see [5(5)] above), this question of additional tax does not arise. However, if I am wrong in reaching the conclusions set out above, I do not consider that the position adopted by any of the taxpayers was not "reasonably arguable". It is common ground that whether a matter is "reasonably arguable" is a question to be determined objectively:
Walstern v Federal Commissioner of Taxation 2003 ATC 5076; (2003) 138 FCR 1, 26;
Pridecraft Pty Ltd v Federal Commissioner of Taxation 2005 ATC 4001; (2004) 213 ALR 450 at [108]-[109];
Federal Commissioner of Taxation v R & D Holdings Pty Ltd 2007 ATC 4731; (2007) 160 FCR 248, 260-61 and
Cameron Brae Pty Ltd v Federal Commissioner of Taxation 2007 ATC 4936; (2007) 161 FCR 468, 488.

235. A reasoned argument was and can be made to support the contention that the various substantive tax laws should apply in the manner

ATC 9539

contended for by the applicants. In relation to Div 243, the position is far stronger - this was the first decision concerning that division.

Conclusions and orders

236. I do not propose to make final orders. Instead, I will direct the parties to confer and jointly file short minutes of proposed orders giving effect to these reasons by 4:00 pm on 3 April 2009. If the parties are unable to agree, they are to submit a joint statement by 4:00 pm on 3 April 2009 identifying: (1) the point(s) of agreement; (2) the point(s) of disagreement; and (3) the respective positions of the parties on the point(s) of disagreement, in which case I will list the matter for further directions or hearing as necessary. If further directions or hearing are sought, the parties should consult amongst themselves and then contact my chambers with a list of mutually agreeable dates and an estimated time required for the proposed directions or hearing.

SCHEDULE "A" - PAR [21] OF THE REASONS FOR DECISION
    Loan Balances  
  Company 1995 1996 Principal Company Activities
1. BHP Limited 676.1 1,354.5 Holding company, Iron and Steel Production and Mining
2. AWI Holdings Pty Ltd 119.2 163.1 Holding company for the Australian Wire Industries group which was engaged in the manufacture of wire, wire ropes, and fence posts primarily for farming.
3. BHP Australia Coal Pty Ltd 2,711.0 4,606.0 Coal mining, minerals exploration and manager
4. BHP Direct Reduced Iron Pty Ltd - 54.7 Development of HBI plant
5. BHP Engineering Pty Ltd 23.7 22.5 Engineering service company
6. BHP Information Technology Pty Ltd 27.6 21.4 Information Technology manager for the BHP Group and supply of computer services
7. BHP International Holdings Limited 6.2 10.3 Holding company and China representative office (Australian resident)
8. BHP Iron Ore Pty Ltd 2.8 22.2 Provided Management and Marketing services to the Australian Iron Ore business.
9. BHP Iron Pty Ltd 15.3 - Holds leases relating to the Goldsworthy Joint Venture and iron ore mining.
10. BHP Materials Pty Ltd 99.8 - Steel Trading company for Steel activities. It initially marketed redundant equipment on behalf of the Steel Group. Also involved in diverse activities such as timber importation.
11. BHP Minerals Pty Ltd 433.9 704.5 Iron ore and coal mining company
12. BHP Petroleum Pty Ltd 3,921.4 5,775.4 Management company

ATC 9540

13.		 BHP Petroleum (Bass Strait) Pty Ltd 30.3 60.0 Supplier of Oil and Gas from Bass Strait as part of the Esso/BHP Joint Venture - Hydrocarbons, exploration, development and marketing.
14. BHP Queensland Coal Limited 2.9 - Coal Mining activities in Queensland.
15. BHP Rail Products Pty Ltd 1.9 - Based in both Adelaide and Whyalla, this company produced and marketed steel rail sleepers and the fasteners that attach the rails to the sleepers. Marketed under the TrakLok Brand.
16. BHP Refractories Pty Ltd 65.7 82.8 Manufacture and installer of refractory (brick) linings for use in the repair or construction of furnaces and ladles. The material was used primarily in steel blast furnaces and smelting operations.
17. BHP Steel (AIS) Pty Ltd 965.9 2,237.3 Involved in coal mining, coke making, sinter production, Iron and Steelmaking and the casting of steel into slabs and the rolling of slabs into plates (for ship building) and hot strip coils for use in coil plate, tinplate and black plate manufacture.
        coils for use in coil plate, tinplate and black plate manufacture.
18. BHP Steel (JLA) Pty Ltd 409.2 818.0 Acquires slabs and hot strip from BHP Steel (AIS) Pty Ltd and rolls the material (roll forming) into longer flat material which is then coated as zincalum or colourbond products.
19. BHP Transport Pty Ltd 334.7 351.4 BHP Transport owned and operated a fleet of ships to service BHP's import and export businesses. This company also chartered ships as part of its mandate to provide transport services.
20. BHP Titanium Minerals Pty Ltd 39.6 188.8 Titanium minerals mining and holding company.
21. Groote Eylandt Manganese Sales Pty Ltd 15.5 10.5 Marketing company for Manganese ore. Participated in the Elkem joint venture for the processing of manganese ore in Norway.
22. Groote Eylandt Mining Co Pty Ltd 94.7 225.3 Mining and sale of Manganese Ore a feed product for ferro manganese production. The manganese ore is further processed within the Group by Tasmanian Electro Metallurgical Company Pty Ltd.
23. Pilbara Energy Pty Ltd 26.8 114.9 Power Generation to provide gas based electricity generation into the Port Hedland area where BHP operated the Nelson Point and Finucane Island iron ore processing and shiploading operations.
24. Queensland BHP Steel Pty Ltd - 5.1 It transformed steel billets by rolling them into products required by the market in South Eastern Queensland. Products included rods used in concrete construction activities and steel bars.
25. Tasmanian Electro Metallurgical Co. Pty Ltd 29.8 20.3 Ferro alloy manufacturer and marketing.
26. Tubemakers of Australia Limited - 202.2 Manufacture of steel pipe and tube and merchandising of Steel products.
  TOTAL 10,054.0 17,051.2  

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