FC of T v CONSOLIDATED PRESS HOLDINGS LIMITED (No 2)

Judges:
French J
Sackville J
Sundberg J

Court:
Full Federal Court

MEDIA NEUTRAL CITATION: [1999] FCA 1229

Judgment date: 7 September 1999

French, Sackville and Sundberg JJ

Introduction

1. The Consolidated Press Group (``the Group'') comprises a number of corporations formed in Australia and overseas for various purposes associated with the operation of the Group. In the 1980's loan funds for the Group were raised by Consolidated Press International Finance Plc (``CPIF'') which was incorporated in the United Kingdom. It issued bonds to raise money in Swiss Francs to then lend to Group companies. When interest rates on these borrowings began to rise and the value of the bonds began to fall, CPIF agreed with a company called EFS European Finance and Securities Ltd (``EFS'') that it would assume CPIF's future liabilities under the bonds in exchange for a lesser payment based on the present day value of those liabilities. This kind of arrangement is called a ``debt defeasance'' arrangement. There was an ``accounting difference'' or paper gain to CPIF which arose from this transaction. The Commissioner of Taxation took the view that that gain should be treated as income and brought to account as part of the taxable income of Australian companies in the Group namely Consolidated Press Holdings Ltd (``CPH'') and Murray Leisure Group Ltd (``MLG''). To do that he relied upon the provisions of Part X of the Income Tax Assessment Act 1936 (``the Act'') which provide for the notional repatriation, for tax purposes, of income earned by overseas corporations controlled by Australian companies or individuals.

2. The Commissioner's assessments issued to CPH and MLG, based on bringing in the debt defeasance gains, were objected to, the objections were disallowed and the disallowance decisions were challenged on appeal to this Court. Those appeals were successful and Hill J ordered, in each case, that the objection decision be set aside and the matter remitted to the Commissioner [reported at 98 ATC 5009].

3. Two other companies in the Consolidated Press Group under a new holding structure set up in the Bahamas in 1990 were Consolidated Press International Holdings Ltd (``CPIHL(B)'') and Consolidated Press International Ltd (``CPIL(B)''). Neither of these companies was a resident of Australia. CPIHL(B) controlled CPIL(B). Under the provisions of Part X their income, like that of CPIF, was attributable to CPH and MLG.

4. In 1991 and 1992 CPIL(B) made interest payments to companies not residents of Australia. CPH and MLG argued that these interest payments were deductions which should come off the attributable income of CPIL(B) in respect of which they are assessed for tax in Australia. But because CPIL(B) was controlled by CPIHL(B) and CPH and MLG were both ``associates'' of CPIHL(B) for the purposes of the Act, CPIL(B) was assumed to be a resident of Australia for the purposes of Division 16F of the Act. That Division deals with so called ``thin capitalisation''. Thin capitalisation exists where a company resident in Australia is inadequately capitalised by equity, and is in essence funded by borrowings

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from overseas. Division 16F disentitles such companies to full deductions for interest payable on the foreign debt for the purpose of calculating taxable income in Australia.

5. Applying Division 16F to CPIL(B) on the assumption that it was a resident of Australia by virtue of Part X, the Commissioner in effect disallowed the interest payments it had made to other companies overseas as deductions against the income it earned. That income was in turn attributed to CPH and MLG.

6. The 1991 and 1992 assessments were challenged in relation to this issue. The objections were disallowed and on appeal to Hill J his Honour found for the Commissioner. The Commissioner appeals against his Honour's decisions on the debt defeasance issue and CPH and MLG cross-appeal on the thin capitalisation issue.

7. As will be seen this case is concerned with technical questions of statutory construction in an area of the law characterised by considerable complexity.

Statutory framework - Controlled foreign corporations

8. A description of the purpose and essential features of the provisions of Part X of the Act dealing with controlled foreign corporations and the provisions of Division 16F dealing with thin capitalisation will assist in understanding the facts and issues involved in these appeals. What follows draws upon the exposition of the primary judge, the accuracy of which was not challenged.

9. Part X was inserted into the Act in 1991 and applied to the 1991 and subsequent tax years. It was enacted to give effect to an Economic Statement issued in 1989 as part of a package of measures designed to amend Australian tax law relating to foreign source income. The part of the package that is of present relevance in substance prescribes an accrual system of taxing certain foreign source income, rather than taxing it as and when derived by the taxpayer.

10. The mischief to which that part of the legislation was directed can be illustrated by a simple example. An Australian resident corporation might wish to invest in a low tax or no tax country in order to receive non-business income from a foreign source. If the investment were effected directly, the Australian resident corporation would pay Australian tax in the year of income in which the foreign source income was derived. It would receive a tax credit for any tax payable in the foreign country. If, however, the investment were carried out through a foreign company that was not a resident of Australia, but which was controlled by the Australian resident, the income would be taxed only at the rate (if any) applicable to the overseas company and no Australian tax would be payable. A distribution of the income derived by the foreign company, by way of dividends to the Australian controller, would of course attract Australian tax. But if the income of the foreign company were returned to Australia in a manner that did not attract tax, such as by way of loan to the Australian resident controller or in the form of capital, the income would escape Australian tax.

11. The legislative solution was to tax Australian resident taxpayers who controlled a ``controlled foreign corporation'' (a CFC) on the foreign source income derived by the CFC in the relevant year of income. According to the Explanatory Memorandum to the Taxation Laws Amendment (Foreign Income) Bill 1990, which inserted Part X:

``The broad aim of the proposals in relation to companies is to attribute to Australian residents income, other than active business income, derived by foreign companies that are controlled by Australian residents other than in the case of a company that is subject to a tax system comparable to Australia's or is predominantly engaged in active business.''

12. Section 316(1) describes one of the objects of Part X as ``to provide for certain amounts to be included in a taxpayer's assessable income (Division 9) in respect of... the attributable income of a CFC (section 456)...''. Section 456(1) (which is in Division 9) provides in part that:

``... where a CFC has attributable income for a statutory accounting period in respect of an attributable taxpayer, the taxpayer's attribution percentage of the attributable income is included in the assessable income of the taxpayer of the year of income in which the end of the statutory accounting period occurs.''

13. Section 340 sets out the characteristics a company must possess in order that it be a CFC. Section 361 sets out the characteristics an entity

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must have in order that it be an attributable taxpayer in relation to a CFC. The ``attribution percentage'' of an attributable taxpayer in relation to a CFC is calculated in accordance with s 362.

14. Sections 381, 382 and 383 deal with the calculation of ``attributable income''. Section 381 provides:

``Where, at the end of a statutory accounting period (in this Division called the `eligible period' ) of a company:

(a) the company is a CFC; and

(b) there are one or more attributable taxpayers in relation to the company;

the attributable income of the company (in this Division called the `eligible CFC' ) for the eligible period is calculated separately for each such attributable taxpayer (in this Division called the `eligible taxpayer' ) in accordance with this Division.''

15. Section 382 provides:

``(1) The attributable income is the amount that would be the eligible CFC's taxable income for the eligible period if certain assumptions were made.

(2) For the purposes of describing those assumptions, amounts of assessable income, allowable deductions and exempt income that are to be taken into account in calculating the taxable income are referred to respectively as notional assessable income, notional allowable deductions and notional exempt income.''

16. Section 383 describes the basic assumptions to be made for the purpose of the calculation. They are:

``(a) that the eligible CFC is a taxpayer and a resident, within the meaning of section 6, during the whole of the eligible period; and

(b) that the eligible period is a year of income, being the year of income of the eligible taxpayer in which the eligible period ends; and

(c) that this Act is modified in accordance with Subdivisions B to D; and

(d) whichever of the assumptions in section 384 or 385 applies.''

17. Subdivision B requires certain provisions of the Act to be disregarded (eg s 389) and other provisions to be modified (eg s 396) in calculating the attributable income of an eligible CFC.

Statutory framework relevant to debt defeasance issue

18. Where, as in this case, the CFC is a resident of an unlisted country, the income component of the attributable income calculation, which is the notional assessable income, is to be calculated on the assumptions stated in s 384(1):

``(a) that the only amounts of notional assessable income are those to which subsection (2) applies; and

(b) that all other income is notional exempt income.''

The amounts included in notional assessable income are set out in s 384(2). It is not in dispute that the only relevant paragraph is par 384(2)(a):

``where the eligible CFC does not pass the active income test for the eligible period in relation to the eligible taxpayer - amounts that would be included in its notional assessable income for the eligible period under this Act as modified in accordance with Subdivisions B to D if the only income or other amounts derived by it during the eligible period, and any earlier statutory accounting period, were adjusted tainted income (within the meaning of section 386);''

The only income which comprises notional assessable income for the purposes of this case is adjusted tainted income. By s 386 the references in ss 384 and 385 to ``adjusted tainted income'' are ``references to amounts that would be passive income, tainted sales income or tainted services income if certain modifications were made to the provisions of Division 8''. It is only passive income that is relevant for present purposes.

19. Passive income is defined in s 446(1) thus:

``Subject to this Division, for the purposes of this Part, the following amounts are passive income of a company of a statutory accounting period:

(a) dividends (within the meaning of section 6) paid to the company in the statutory accounting period;

...

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(d) tainted interest income derived by the company in the statutory accounting period;

(e) annuities derived by the company in the statutory accounting period;

...

(j) income derived from carrying on a business of trading in tainted assets;

(k) net gains that accrued to the company in the statutory accounting period in respect of the disposal of tainted assets.''

20. The definition of ``passive income'' is, by virtue of s 386(1), subject to the modifications set out in s 386(2). Those modifications substitute for par 446(1)(k) the words ``amounts derived from the disposal of tainted assets''. ``Tainted assets'' are defined in s 317 and include loans, bonds, bills of exchange, promissory notes [par (a)] and an asset other than (i) trading stock or (ii) or any other asset used solely in carrying on a business [ par (c)].

Statutory framework - Thin capitalisation

21. Division 16F - ``Thin capitalisation by non-residents'' - was introduced into the Act in 1987 to apply to assessments of income commencing on 1 July 1987. The Division is concerned with resident corporations which, in the view of the legislature, are inadequately capitalised by equity and are funded in essence by borrowings from overseas. But for Division 16F, those companies would be entitled to deductions for interest payable on the foreign debt for the purpose of calculating taxable income in Australia. The interest payable by the resident corporation to its foreign controller or to the associates of that controller would be subject to withholding tax at the rate of 10 per cent.

22. Division 16F was designed to reduce the deduction available to an Australian company for interest payable to a foreign controller or its associates where the debt to equity ratio exceeds three to one. Thus s 159GZS(1) provides that where:

``(a) an amount of foreign debt interest is, apart from this Division, allowable as a deduction from the assessable income of a year of income of a taxpayer being a resident company; and

...

(b) the greatest total foreign debt of the taxpayer at any time in the year of income exceeds the foreign equity product of the taxpayer of the year of income;

a proportion of the amount of the foreign debt interest ascertained in accordance
                 E
with the formula - ,
                 D
where
              
E is the amount of the excess referred to in paragraph (b); and

D is the amount of foreign debt referred to in that paragraph;

is not so allowable as a deduction.''

23. The various expressions used in the sub- section are defined in or by reference to s 159GZA. The expression ``foreign debt interest'' means ``interest payable on foreign debt''. The expression ``foreign debt'' in relation to a resident company is defined in s 159GZF(1) as:

``... the balance outstanding on any amount owing by the company, where:

(a) interest is or may become payable to a foreign controller, or to a non-resident associate of a foreign controller, of the company in respect of the amount owed;

(b) the interest is or will be, apart from this Division, allowable as a deduction from the assessable income of the company of any year of income; and

(c)... the interest is not, or would not be, assessable income of any year of income of the foreign controller or non-resident associate to whom it is or becomes payable.''

24. The expression ``foreign equity'' in relation to a resident company is defined in s 159GZG as the sum of a number of amounts, including the paid-up value of all shares and interests in shares in the company beneficially owned at the end of the year of income by foreign controllers or their non-resident associates. The expression ``foreign equity product'' means, so far as applicable to the present case, the amount ascertained by multiplying the foreign equity of a person being a resident company or a foreign investor of the year of income by three. The expression ``foreign controller'' in relation to a resident company is defined in s 159GZE. The word ``associate'' is defined in s 159GZC.

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Factual background - Debt defeasance

25. CPH is the holding company of the Group. CPIF became part of the Group for the specific purpose of raising loan capital for members of the group by the issue of Swiss Franc denominated bearer bonds. Money raised was to be on-lent to companies of the Group or for CPIF's own investment activity. The learned primary judge characterised the business activities of CPIF as being [at 98 ATC 5024]:

``... nothing other than the borrowing of money and the lending of funds through the Consolidated Press Group of international companies by way of loan or bill discounting so as to produce a profit.''

In a prospectus published in 1985 CPIF described its activities thus:

``The purpose of Consolidated Press International Finance Plc (`the company') is to act as a finance company. Its activity includes the raising of guaranteed and non- guaranteed loans, the issue of guaranteed and non-guaranteed bonds and notes and the raising of funds through promissory notes and similar instruments. Such funds are used for on-lending to companies of the Consolidated Press Holdings Ltd group (`the CPH Group') or for the company's own investment activity.''

It was necessary to establish CPIF as a special purpose company incorporated outside Australia because advice to the group was that withholding tax would otherwise be payable on the interest payable to bond holders. The United Kingdom was chosen as its place of incorporation because that country was not regarded as a tax haven by Australian authorities and because, inter alia, provided CPIF was managed and controlled from outside the UK, no UK withholding tax would be payable on interest payable to bond holders. The advantage of using Swiss Franc bonds derived from the low interest rates the bonds would carry and the apparent stability of the Swiss Franc/Australian dollar exchange rate.

26. In March 1984 and August 1985 CPIF entered into agreements for the public issue of bonds on the Swiss bond market with S G Warburg Soditic SA and consortia of banks in respect of each agreement. Each agreement was guaranteed by CPH. The bonds to be issued in each case had a face value of SFr200 million and an interest coupon of 6.25 per cent. They were to mature in 1994 and 1995 respectively. Repayment of the principal amounts outstanding on the bonds was due in April 1994 and August 1995. There was provision for early redemption of three per cent of the aggregate principal amounts of the bonds originally issued if they were trading at or below par in the periods from 17 August 1987 to 17 April 1993 for the 1984 bonds, and 20 August 1988 to 20 August 1994 for the 1985 bonds.

27. The 1984 bonds were issued by CPIF on 17 August 1984 and the 1985 bonds on 14 August 1985. By the end of 1989 their market price had fallen. They were trading in Swiss secondary markets at substantial discounts. As at 12 November 1989 the 1984 bonds were trading at 88 per cent of their face value on and the 1985 bonds at 76.5 per cent of their face value. There was nervousness in Swiss franc capital markets about the creditworthiness of Australian borrowers. In addition adverse exchange movements had resulted in exchange losses of $US75.5 million, the Australian dollar having declined by more than 40 per cent against the Swiss franc in this period. At 29 December 1989 and 19 January 1990, 1984 bonds with a nominal value of SFr5,325,000 had been redeemed leaving 1984 bonds with a nominal value of SFr194,675,000 outstanding. On the same date 1985 bonds with a nominal value of SFr10,420,000 had been redeemed, leaving 1985 bonds with a nominal value of SFr189,580,000 outstanding.

28. The discount at which the bonds were trading in secondary markets provided CPIF with an opportunity to recoup part of the exchange losses. The options in this respect were:

1. To buy back outstanding bonds on the market. The two principal disadvantages of this course were that there was little volume available at existing prices and that it would be necessary to fund a buyback program by borrowing Swiss francs or reissuing on the Swiss capital market. Market sentiment with respect to Australian borrowers precluded this course.
2. To have a third party assume the obligations of CPIF in respect of principal and interest under the bonds, that is to say to enter a debt defeasance agreement.

29. The basic idea of debt defeasance was helpfully described by Hill J as a member of the

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Full Court in
FC of T v Unilever Australia Securities Ltd 95 ATC 4117; (1995) 56 FCR 152. As his Honour pointed out, the 1980's generated innovative financial arrangements some of which grew from the climate of rising interest rates and increased inflation and which would have been unthinkable in more stable times. One such arrangement was known as ``debt defeasance''. The strategy of debt defeasance rested upon the concept of the time cost of money. Companies with long term borrowings at low interest rates could obtain a financial advantage if those borrowings could be repaid where the present value of the liability was less than the face value repayable. His Honour said, at ATC 4136-4137; FCR 178:

``Debt defeasance is somewhat of a misnomer. In simple terms it involved a borrowing company making a payment to a third party in consideration of that third party accepting responsibility for the borrowing company's obligation to repay debentures on maturity. However, the liability of the borrowing company was not, in a legal sense, defeased at all. The borrowing company continued to be liable to meet the debentures on maturity, but the assumption of liability by the third party of good financial standing had the practical consequence that the liability of the borrowing company would be satisfied by payment by the third party directly to the debenture holders. The `defeasance' was practical rather than legal.''

30. CPIF decided to adopt the defeasance option. On 29 December 1989 it entered into obligation assumption agreements with EFS which was a company incorporated in the British Virgin Islands acting as trustee of EFS European Finance and Securities Settlement. Under the agreements EFS assumed the obligations of CPIF to the bond holders pursuant to the 1984 and 1985 bonds. By additional obligation assumption agreements executed on the same date with another member of the group incorporated in the United Kingdom, Consolidated Press International Ltd (CPIL(UK)), the latter company agreed to assume all the obligations of EFS with the exception of the payments of principal, interest and commissions. On 19 January 1990 EFS assumed the CPIF financial obligations in respect of the outstanding 1984 and 1985 bonds as and when the financial obligations became due and payable whether at maturity, by acceleration or on redemption. In consideration of this CPIF transferred the sums of SFr179,725,000 and SFr189,580,000 to EFS. Under the additional obligation agreements CPIL(UK) assumed all of the obligations under the 1984 and 1985 bond agreements with the exception of the payment of principal, interest and commissions. In consideration of this EFS transferred the sums of SFr8,175,000 and SFr2,220,000 to CPIL(UK).

31. Like the defeasance agreements described by Hill J in Unilever the obligation assumption agreements entered into in this case could be described as debt defeasance agreements only in a practical commercial sense and not in any strict legal sense - see also Unilever at ATC 4123; FCR 160 per Beaumont J.

32. The consolidated profit and loss account of CPIF for the year ended 30 June 1990 showed an extraordinary item loss of $1,743,000 comprising a profit on transfer of liabilities for bonds issued of $34,306,000 offset by an amount of $36,049,000 described in the notes to the accounts as ``profit written back against the unrealised exchange loss previously absorbed by former parent company''. The liability associated with the Swiss franc borrowing was removed from the balance sheet.

33. EFS paid interest and commission on the 1984 and 1985 bonds in accordance with the obligation assumption agreements. Some of the 1984 and 1985 bonds were redeemed in 1992 leaving bonds with a nominal value of SFr189,600,000 still outstanding. Bonds having a face value of SFr114,730,000 were cancelled in April 1992 at the request of CPIF and CPIL(B). Further 1985 bonds were redeemed between February and 20 May 1992 so that at the end of that time 1985 bonds with a nominal value of SFr68,850,000 were still outstanding. A further assumption agreement was made in respect of the outstanding 1985 bonds in April effective as at 20 May 1992.

Factual background - Thin capitalisation

34. In or about 1989 the Group had been seeking advice about the impact of proposed changes to the tax laws in Australia and the United Kingdom which might lead to the group being exposed to double taxation. The advice received and ultimately implemented involved relocating the group's overseas holding

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structure from the United Kingdom to a tax haven.

35. In the event the two Group companies incorporated in the United Kingdom, Consolidated Press International Holdings Ltd (``CPIHL(UK)'') and CPIL(UK) were placed in voluntary liquidation in April 1990 and were replaced with entities based in the Bahamas - CPIHL(B) and CPIL(B). MLG and CPH agreed to sell their holdings in CPIL(UK) and CPIHL(UK) to CPIL(B) in April 1990. This restructuring and associated transactions are the subject of discussion in related appeals dealing with dividend stripping and schemes said to otherwise fall within Part IVA of the Act.

36. Neither CPIL(B) nor CPIHL(B) was a resident of Australia. Each was a CFC as defined in s 340. CPH and MLG were attributable taxpayers in relation to CPIL(B). CPH held 452,346,000 shares of $US1 each in CPIL(B) (approximately 54 per cent of the issued capital), while MLG held 380,625,319 shares of $US1 each in CPIL(B) (approximately 46 per cent). Consequently, in respect of any ``attributable income'' for the years in question CPH had an ``attribution percentage'' of approximately 54 per cent and MLG an ``attribution percentage'' of approximately 46 per cent. CPIHL(B) held 102 $US1 shares in CPIL(B). None of this is in dispute.

37. The operative provision of Part X is s 456(1), which we have set out. Applying its terms to the facts, CPIL(B) (the CFC) had attributable income for each of the statutory accounting periods. That attributable income was in respect of CPH and MLG, each an attributable taxpayer. The effect of the section is to include in the attributable income of CPH and MLG approximately 54 per cent and 46 per cent respectively of the attributable income of CPIL(B) for each statutory accounting period.

38. In the 1991 year of income, CPIL(B) paid or credited to companies which were not residents of Australia amounts of interest totalling A$4,287,599. In the 1992 year it paid or credited to companies which were not resident of Australia amounts of interest totalling A$15,638,106. Each of the payee companies was a non-resident ``associate'' of CPIHL(B).

The assessments, the objections, the appeals and the cross-appeals

39. The appeals and cross-appeals which are the subject of this judgment relate to assessments and amended assessments issued to CPH and MLG for the 1991 and 1992 years of income.

40. On 21 December 1994 the Commissioner issued assessments to CPH in respect of the years of income 1991 and 1992 and an amended assessment to MLG in respect of the year of income 1991. On 14 May 1996 amended assessments were issued to the two companies in respect of the 1991 year. On 10 May 1996 the Commissioner issued an assessment to CPH in respect of the 1992 year of income. An assessment and amended assessment in respect of that year of income were issued to MLG on 21 December 1994 and 14 May 1996.

41. By the first assessments issued for the 1991 year of income the Commissioner adjusted the taxable incomes of CPH and MLG by, inter alia, increasing the amount of attributable income of the international group as returned and reducing the attributable percentage interests of CPH and MLG in the international group from 54.3 per cent and 45.7 per cent respectively to 33 per cent. In issuing the amended assessments for the 1991 year the Commissioner further increased the taxable income of the companies by restoring the attributable percentage interests to those originally returned, namely 54.3 per cent and 45.7 per cent.

42. In relation to the first assessments for 1991 the Commissioner took the position that, pursuant to the provisions of Division 16F, CPIL(B) was not allowed a deduction for foreign debt interest thus increasing the amount of attributable income to be assessed against the two Australian companies pursuant to Part X. This aspect of the first assessment raises the so called ``thin capitalisation'' issue.

43. In the same assessments the Commissioner asserted that the difference between the amount of the financial obligations assumed by CPIF in the 1984 and 1985 assumption agreements and the amount paid to EFS pursuant to those agreements resulted in a gain to CPIF. On that basis the attributable income of CPIF for the 1991 income year was greater than that returned by an amount said to be the sum of:

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(a) that portion of the 1984 assumption gain referable to the financial obligations of CPIF under the 1984 bonds which became due and payable in the 1991 accounting period; and
(b) that portion of the 1985 assumption gain referable to the financial obligations of CPIF under the 1985 bonds which became due and payable in the 1991 accounting period.

Thus the debt defeasance issue was raised. The 1992 assessments and amended assessments also increased the attributable income of CPIL(B) and CPIF for that year of income in reliance upon Division 16F and the debt defeasance contentions respectively.

44. Objections to the assessments were disallowed and the objection decisions were appealed to his Honour. In each case his Honour ordered that the appeal be allowed, the objection decision be set aside and the matter be remitted to the Commissioner to be dealt with in accordance with his Honour's reasons. His Honour found for the Commissioner on the application of Division 16F, that is on the thin capitalisation issue. However on the debt defeasance issue he found the defeasance profit earned by CPIF should have been treated as notional exempt income and thus excluded from the computation of attributable income. The assessments were therefore wrong to that extent. The Commissioner appealed against each of his Honour's decisions on the debt defeasance issue. CPH and MLG each cross- appealed on the thin capitalisation issue. In addition, CPH and MLG filed notices of contention asserting that his Honour's decisions on the debt defeasance issue should be upheld on grounds that his Honour had erred in favour of the Commissioner in certain of his findings on that issue.

45. The appeals and the assessments to which they relate are as follows:

                  Year of Income        Issued          Appeal No

CPH Assessment         1991         21 December 1994     1176/98

CPH Amended
Assessment             1991         14 May 1996          1177/98

MLG Amended
Assessment             1991         21 December 1994     1180/98

MLG Assessment         1991         14 May 1996          1181/98

CPH Assessment         1992         21 December 1994     1178/98

CPH Amended
Assessment             1992         10 May 1996          1179/98

MLG Assessment         1992         21 December 1994     1182/98

MLG Amended
Assessment             1992         14 May 1996          1183/98

The primary judge's reasoning - Thin capitalisation

46. Absent the general provisions of Part X, Division 16F would have no application to interest payable by CPIL(B) to its non-resident associates, because CPIL(B) is not a resident company and thus would have no foreign debt (see s 159GZF) and no amount of foreign debt interest would be allowable as a deduction from CPIL(B)'s assessable income (see s 159GZS(1)).

47. The question before his Honour was whether Part X does produce a different result. It was common ground that CPIHL(B) is a ``foreign controller'' of CPIL(B) and the payees are associates of CPIHL(B) for the purposes of Division 16F. The foreign equity of CPIL(B) is $102, being the 102 ``B'' class CPIL(B) shares held by CPIHL(B). If Division 16F applies, any foreign debt interest in excess of $306 becomes subject to the Division. In reliance on the assumption in s 383(a), namely that CPIL(B) is a resident, the Commissioner applied Division 16F so as to deny CPIL(B) a deduction for a proportion of the interest payments made to the non-resident companies for the purpose of computing the attributable income passing ultimately through to CPH and MLG. The primary judge upheld the Commissioner's

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approach and the question of this part of the appeal is whether his Honour was correct.

48. The primary judge noted that one of the assumptions required by s 383 is that the Act is modified in accordance with Subdivisions B to D and that s 389 (which is in Subdivision B) provided that, for the purpose of applying the Act in calculating the attributable income of an eligible CFC, certain provisions were to be disregarded. Those provisions did not include Division 16F. His Honour then observed that s 389 had been amended in 1997 so as to add Division 16F (and other provisions) to the list of provisions to be disregarded. He said that it was reasonable to take into account the amendment to s 389 excluding the operation of Division 16F as indicative of the parliamentary intention that prior to that amendment Division 16F was to be applied in calculating the attributable income of an eligible CFC.

49. His Honour continued [at 98 ATC 5018]:

``In respect of the present dilemma, it is not impermissible to conclude that the initial legislative purpose was that Division 16F should have application in computing the attributable income of an eligible CFC. Clearly there is nothing which suggests the contrary. The prime purpose of Division 16F is to disallow deductions in cases where thin capitalisation is apparent. The usual reason Division 16F would apply is where interest is accrued. So it is tolerably clear that the legislative purpose to which effect should be given is that in the computation of attributable income and on the assumption of residency of the CFC where there is the requisite thin capitalisation, there should be a disallowance for interest, or part thereof, paid to a CFC or associate as long as that interest income did not form part of the assessable income of the recipient. This means that in interpreting s 159GZF and the corresponding provisions of s 159GZS the reference to an amount of foreign debt interest being, apart from Division 16F, allowable as a deduction must comprehend an amount intended to be taken into account in the computation of the attributable income of the CFC as a notional deduction. Hence, for example, s 159GZF is to be interpreted as applicable (subject to the other matters referred to in the subsection) where the interest payable by the CFC is, on the assumption that it is a resident, allowable as a deduction but only for the purpose of the computation of attributable income under Part X.''

Accordingly his Honour upheld the Commissioner's contention that CPIL(B) was not entitled to a deduction for foreign debt interest, with the result that the amount of attributable income on which CPH and MLG were to be assessed was increased.

Thin capitalisation - Discussion

50. Whether the Commissioner was entitled to apply Division 16F so as to reduce the deductions depends on whether the three elements of the definition of ``foreign debt'' in s 159GZF(1) are satisfied. The first is that interest is or may become payable to a foreign controller or to a non-resident associate of a foreign controller of a resident company in respect of any amount owing by the company. The Commissioner's case was that the interest paid by CPIL(B) was payable to non-resident associates of CPIHL(B), which was a foreign controller of CPIL(B), a resident company because of the assumption required by s 383(a).

51. The respondents disputed that CPIHL(B) was a foreign controller of CPIL(B), on the ground that CPIL(B) is not ``truly'' a resident company. This submission was not put to the primary judge and is not mentioned in the grounds of cross-appeal. But in any event it has no substance. Section 383(a) requires residence to be assumed for the purpose of determining an eligible CFC's taxable income (the taxable income of the company being the amount of its ``attributable income'').

52. The assumptions that are to be made for the purpose of calculating the CFC's taxable income incorporate all the provisions of the Act, save for the specific modifications to the Act deemed to be made in accordance with Subdivisions B to D of Division 7 (see s 383(c)). In particular, s 389 requires certain provisions to be disregarded ``for the purpose of applying this Act in calculating the attributable income of the eligible CFC''. Division 16F is not one of them. The omission is, as it were, underlined by the 1997 amendment of s 389 so as to include that Division in the list of provisions that are to be disregarded.

53. The second element of the definition in s 159GZF(1) is that the interest is or will be, but for Division 16F, allowable as a deduction from

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the assessable income of CPIL(B) of a year of income. The Commissioner's case is that, were it not for Division 16F, the interest would be allowable as a deduction to CPIL(B) under s 51(1). The respondents dispute this on the ground that the interest is only a ``notional deduction'' under Part X, not an actual deduction. This is a reference to s 382(2), which speaks of notional assessable income, notional allowable deductions and notional exempt income.

54. In our view the respondents' contention mis-states what is required by ss 382 and 383. Section 382(1) requires a CFC's taxable income to be ascertained on the basis that certain assumptions are made. These include the assumptions in s 383, in particular that the CFC is a resident and a taxpayer. Accordingly, the provisions of the Act, other than Part X, must be applied to CPIL(B) on those assumptions. The result is that CPIL(B) had assessable income within s 25(1) and, but for Division 16F, allowable deductions within s 51(1) and s 159GZF(1)(b), and not simply notional assessable income and notional allowable deductions as contended for by the respondent.

55. Section 382(2) employs the concepts of notional allowable deductions and notional assessable income only for the purposes of describing some of the assumptions required by s 382(1), namely those in ss 384 and 385, though not those in s 383. Section 382(2) simply tells the reader that ``for the purpose of describing those assumptions'', amounts of assessable income and allowable deductions are referred to as notional assessable income and notional allowable deductions. The amounts that that sub-section says are elsewhere referred to as notional amounts, are in fact actual amounts - ``amounts of assessable income, allowable deductions and exempt income that are to be taken into account in calculating the taxable income''. The notional amounts are relevant to the description of the assumptions contained in ss 384 and 385, but are irrelevant when applying the other provisions of the Act in order to determine the amounts of assessable income and allowable deductions that are to be taken into account in calculating the taxable income of the CFC on the basis of those assumptions.

56. The submission we have thus rejected is curious and self-defeating. If it be correct, the calculation of CPIL(B)'s taxable income, for the purpose of determining its ``attributable income'', could never include a deduction for interest pursuant to s 51(1) of the Act since it never derived assessable income, only notional assessable income.

57. The third element of the definition in s 159GZF(1) is that the interest is not or would not be assessable income of the foreign controller or non-resident associate of the foreign controller to whom it is or becomes payable. The Commissioner's case is that the interest did not, and would not, form part of the assessable income of CPIHL(B) or of its associates who in fact received it. The respondents submit that the words ``assessable income... of... the non-resident associate'' should be construed so as to include the notional assessable income of the non-resident associate under Part X. It is said that such a construction achieves a natural symmetry with a construction of the words ``allowable as a deduction from the assessable income'' in par (b) of s 159GZF(1) as including a notional allowable deduction under Part X. It is said that a construction which achieves a natural symmetry either way is to be preferred to one which does not.

58. We do not accept this submission. Section 159GZF(1) is relevant in the present case to determine whether the amounts of interest accrued by CPIL(B) are allowable deductions in determining its taxable income on the assumption that it is a resident taxpayer. There is no assumption, as the taxpayer would have it, that the entity to which the interest is paid is a resident.

59. The elements of the definition of ``foreign debt'' in s 159GZF(1) being satisfied, it follows that the Commissioner's calculation of the proportion of the amount of the foreign debt interest that is not allowable as a deduction because of s 159GZS is correct.

60. The respondents challenged the primary judge's reliance on the amendment to s 389 as evincing an intention that prior to the amendment Division 16F was to be applied in calculating the attributable income of an eligible CFC. It was submitted that s 389 was not exhaustive of those provisions of the Act which have no substantive operation for the calculation of the attributable income of a CFC and only provided for specific provisions to be disregarded where they were potentially

ATC 5001

relevant to the calculation of attributable income.

61. We do not accept this characterisation of the function of s 389. It is plainly an exhaustive list of the provisions that are to be disregarded. It is inconsistent with its clear language to treat it as if it provided that ``the following provisions, amongst others, are to be disregarded''. Its natural meaning is reinforced by the assumption in s 383(c) that the Act is ``modified in accordance with Subdivisions B to D''. That must mean modified to that extent and not otherwise. We agree with the primary judge that, in accordance with authorities such as
Grain Elevators Board (Victoria) v Dunmunkle Corporation (1946) 73 CLR 70 at 85-86 and
Cape Brandy Syndicate v Inland Revenue Commissioners [1921] 2 KB 403 at 414, it is permissible to see the amendment of s 389 as indicative of the Parliamentary intention that, prior to amendment, Division 16F was to be applied in calculating the attributable income of an eligible CFC. However, it is not necessary to rely on this indication to produce that result, for in our view that is the plain meaning of the relevant provisions.

62. The respondents were critical of the primary judge for having implicitly accepted a submission by the Commissioner that in ascertaining the meaning of s 389 prior to the 1997 amendment reliance might be placed on the Explanatory Memorandum to the Bill which became the Act which effected the amendment. In
Hunter Resources Ltd v Melville (1988) 164 CLR 234 at 241, Mason CJ and Gaudron J refused to allow resort to extrinsic material relating to provisions enacted after those the meaning of which was in question. Contrast the view of Dawson J at 254-255. The primary judge set out a passage from the Explanatory Memorandum which included the following [at 98 ATC 5018]:

``4.28 The thin capitalisation of debt creation rules will no longer apply in determining the attributable income of a CFC because the need for the rules will be greatly reduced following the creation of a short list of countries....

4.29 Section 389 provides a list of provisions that are not to apply in determining the attributable income of a CFC. The insertion of references to Division 16F and Division 16G of Part III into paragraph 389(a) will have the effect of ensuring the thin capitalisation and debt creation rules do not apply in determining the attributable income of a CFC.''

63. The primary judge did not, as contended by the respondents, rely upon the Explanatory Memorandum. He explicitly stated that ``[W]hile one may quarrel with the use of a subsequent explanatory memorandum as a guide to the construction of a previous Act which is amended by the Bill, the subject of the explanation, it was not unreasonable to take into account the actual amendment to s 389''. This criticism of his Honour's reasoning is without substance.

64. Support for the Commissioner's stand is provided by an ``Information Paper'' on Taxation of Foreign Source Income published in April 1989. Chapter 5 deals with ``Calculation of the Attributable Income of a Controlled Foreign Company''. In the paragraphs dealing with international transfer pricing and profit shifting, an example is given which is directly relevant to the subsequent paragraphs dealing with the thin capitalisation rules. It involves a foreign parent company with an Australian subsidiary that owned a CFC. Paragraphs 5.33 and 5.34 are in part as follows:

``5.33 Representations received in response to the [Consultative Document] query how, in general terms, the accruals tax regime would interact with the existing rules on thin capitalisation:

• The first issue is whether those rules should apply in computing the income of a CFC where the income is to be attributed to resident shareholders.

...

5.34 While the scope for the avoidance of tax through the use of excessive gearing of CFC's will be reduced with the introduction of the accruals tax measures, these measures will not eliminate all avenues of possible tax avoidance. If, in the example given in par 5.30, the foreign parent or another of its subsidiaries had an interest in the CFC and excessively geared it, the attributable income of the CFC could be reduced to zero if the thin capitalisation rules were not applied. Because of this possible abuse the thin capitalisation provisions are to apply in the computation of a CFC's income that is to be attributed to resident taxpayers .''

ATC 5002

The emphasis is ours. The respondents argued that the sole purpose of the assumption in s 383(a) is to bring income from all sources within the CFC's assessable income. It was said that the assumption was not intended to exclude from the calculation of the CFC's taxable income a deduction for interest paid by the CFC to its non-resident associates during the relevant period. That submission is inconsistent with the very example given in par 5.34, upon which the taxpayers relied for another purpose. Mr Edmonds SC explained this on the basis that the statutory language had simply failed to implement the obvious intent. On the contrary, we think that the language was entirely apt to achieve the intended result.

65. The taxpayers pointed out that the view adopted by the primary judge of the relationship between Part X and Division 16F, with which we agree, may be to include a payment of interest in the calculation of the attributable income of a recipient CFC, but to exclude the fact of payment in determining the attributable income of the payer CFC. If so, that is the result of what we see as the clear words of ss 382, 383, 389 and 159GZF. At the relevant times, they implemented a policy of protecting the revenue against the shifting of profits from a CFC resident in an unlisted country so that its attributable income could be reduced to zero and did so by applying the thin capitalisation provisions in the computation of a CFC's attributable income.

66. The cross-appeals should be dismissed.

The primary judge's reasoning on the debt defeasance issue

67. His Honour took as his point of departure the requirement emerging from ss 382, 383 and 384 that the attributable income of a CFC be calculated on the assumption that it is a resident of Australia. It was submitted by CPH and MLG that the debt defeasance profit would not, on the statutory assumption of residency, be assessable income. It was also submitted that even if assessable income the profit was not adjusted tainted income.

68. On the first limb of the CPH and MLG argument his Honour relied on
FC of T v Unilever Australia Securities Ltd 95 ATC 4117; (1995) 56 FCR 152 and
FC of T v Orica Limited (formerly ICI Australia Limited) 98 ATC 4494; (1998) 72 ALJR 969 for the proposition that a defeasance profit made in the ordinary course of business will be income according to ordinary concepts and thus assessable income. The defeasance profit was made in the course of and for the purpose of carrying on a business of borrowing and lending. Contrary to the submission for CPH and MLG it did not arise in the course of CPIF going out of business.

69. On the second limb the Commissioner submitted that the profit, being on revenue account made in the ordinary course of business, should be treated as adjusted tainted income. It was common ground that CPIF did not pass the ``active income test'' defined in s 432. The issue between the parties was whether the profit was ``passive income''. His Honour had little difficulty in concluding that the profit was income derived from carrying on a business. However to bring the profit within the definition of passive income in s 446(1)(j) it would be necessary to show it to have been income derived from carrying on a business trading in tainted assets. The debt defeasance transaction did not involve such trading. Nothing in the facts suggested that CPIF ever traded in bonds, or that the bonds it issued (its liabilities) were assets in which it traded. The Commissioner adopted as a first fallback position the proposition that the defeasance profit fell within the description of ``amounts derived from the disposal of tainted assets'' within the meaning of s 446(1)(k) as modified by s 386(2). However his Honour took the view that this paragraph could have no operation. There was no disposal of any asset, tainted or otherwise, in the debt defeasance arrangement. The final fallback position adopted by the Commissioner was that the profit was ``tainted interest income''. But his Honour pointed out that CPIF had received no payment of interest, indeed no payment at all. Its liability to pay interest was satisfied by the assumption party, EFS, but that involved no payment to CPIF.

70. For these reasons his Honour held that the defeasance profit was not ``adjusted tainted income''. Accordingly it was to be treated as ``notional exempt income'' and so excluded from the computation of ``attributable income''. To the extent therefore that the assessments included in the assessable income of CPH and MLG a proportionate amount of the defeasance profit which the Commissioner had claimed to be included in the attributable income of CPIF they were wrong.

ATC 5003

Debt defeasance accounting difference - Profit or gain, capital or income

71. It was asserted for CPH and MLG in their notices of contention that there was no profit or gain to CPIF when EFS performed its obligations. Further, if there were a profit or gain to CPIF it was not income. If either of these contentions could be sustained, no question would arise whether the benefit to CPIF from the debt defeasance agreement was notional assessable income of CPIF under Part X of the Act.

72. CPH and MLG relied upon the decision of the High Court in FC of T v Orica Limited (formerly ICI Australia Limited) 98 ATC 4494; (1998) 72 ALJR 969. There the taxpayer, ICI, and the Trustees of Debenture Trust Deeds, entered into assumption obligation agreements with third parties who assumed liability for the repayment of the debentures issued under the deeds. ICI's objective was to lift restrictions imposed by the deeds on its ratio of liabilities to assets. The amount it paid to the third parties was the present value of the future liabilities. The High Court, by majority, held that the accounting difference between the face value of the debentures and the amount outlaid by ICI was not income according to ordinary concepts nor profit arising from a profit making scheme for the purposes of s 25A of the Act.

73. The Court identified the following important features of the transaction:

1. The accounting difference was the difference between outlays - what the taxpayer actually expended and the outlay it would otherwise have had to make.
2. The taxpayer's liability to its debenture holders was on capital account - the benefit obtained by the taxpayer was a benefit obtained by the discharging of a capital obligation.
3. The transaction was a singular transaction not part of the regular means whereby the taxpayer obtained returns.

These features distinguished the case from that in which a finance company engages in various transactions on capital account yielding a difference properly regarded as a gain or loss on revenue account from the use of the company's working or circulating capital -
AVCO Financial Services Limited v FC of T; FC of T v AVCO Financial Services Limited 82 ATC 4246; (1982) 150 CLR 510 and
Coles Myer Finance Limited v FC of T 93 ATC 4214; (1992-1993) 176 CLR 640. In the Orica case the taxpayer had not acquired an asset which it put to use in a way that realised a profit. Rather, it had acquired rights in relation to the satisfaction of liabilities incurred to provide it with capital in its business. In the majority judgment, the Court said at ATC 4514; ALJR 987:

``... While the difference between outlay and liability must find its reflection in the taxpayer's accounts, the accounting difference between the amount outlaid in a singular transaction to acquire the rights to have another pay sufficient to meet existing capital liabilities of the taxpayer in the future is not a profit or gain to the taxpayer and is not income according to ordinary concepts.''

74. The Commissioner relied upon FC of T v Unilever Australia Securities Ltd (supra). There UAS, the group finance company, had incurred liabilities under borrowings secured by a debenture trust deed and debentures which matured in 1987 and 1989. In 1986 Unilever made an agreement with a state financial institution which undertook to indemnify it against liability for the sum payable as principal on maturity of the debentures. UAS remained liable for interest. The majority of the Full Federal Court held that the agreement with the third party gave rise to a profit properly calculated on a historical cost basis. The gain was derived on revenue account being a profit arising from activities in the carrying on of UAS's financing business. That business had not come to an end at the time of the defeasance agreement. The Commissioner submitted that the facts of that case were relevantly indistinguishable from those of the present case.

75. Lockhart J was of the view that UAS's business included always the elements of borrowing, lending and repaying monies borrowed, servicing the loans including receipt of interest. It was a necessary incident of the business that UAS's debts would be discharged. UAS's business was continuing at all material times. While the defeasance arrangements were unusual they nevertheless generated profit or gain to UAS in the course of its business activities which was income according to ordinary concepts (at ATC 4120; FCR 156). The Commissioner submits that the position of CPIF in the present case is indistinguishable

ATC 5004

from that of UAS in Unilever. Hill J, as a member of the Full Court in that case, identified the real question as whether the profit which it was conceded UAS had made on the defeasance arrangements, was derived on revenue account or capital account. His Honour referred to the Coles Myer and Avco Financial Services cases for the proposition that gains made and losses incurred by a finance company in the course and as an incident of its ordinary business of borrowing money, lending it out and repaying moneys borrowed, are treated as revenue gains and losses. In the case of UAS the profit was derived by UAS in the course of its business activity and was a proceed of that activity. Accordingly, it was income in ordinary concepts.

76. Beaumont J who dissented, was of the view that the debt defeasance arrangement entered into with a view to winding down the taxpayer's activities should not be regarded as something ordinarily encountered in the taxpayer's business. It should thus be treated as having taken place on capital account so that any gain would not constitute income. An application for special leave to appeal to the High Court in the Unilever decision was refused on 13 October 1995.

77. As in the Orica case the accounting difference in this case was a difference between an amount expended and an amount that would have had to be expended absent the agreements. It can also be accepted that, as in Orica, the principal obligations incurred by CPIF under the bonds which it had issued were on capital account. It was the Commissioner's contention, however, that this did not matter. In this respect he relied upon the joint judgment of Mason CJ, Brennan, Dawson, Toohey and Gaudron JJ in Coles Myer 93 ATC 4214; (1993) 176 CLR 640 and particularly at ATC 4221; CLR 663. Their Honours there pointed to the judgments in Avco Financial Services Limited as proceeding on the proposition that the borrowing of money and the repayment of loans by a finance company in the ordinary course of its business are properly to be regarded as transactions on capital account but that the relevant gains and losses are nevertheless revenue gains and losses. Their Honours elaborated on this at ATC 4221; CLR 664:

``... That is because the gains and losses were incurred in the course of and as an incident of making repayments of the borrowed money with which the taxpayer carried on its business as a finance company. The losses or outgoings were incurred in the day-to-day conduct of the business and for the purpose of carrying it on as a going concern. Though the borrowed moneys were capital, it was working or circulating capital from which the taxpayer derived its profits by turning the borrowed money to account at higher rates of interest than those paid to the taxpayer's lenders. The borrowing, as much as the lending, was an integral part of the day-to-day conduct of the taxpayer's profit-earning business.''

78. CPH and MLG sought to avoid the application of this proposition by contending that, as in Orica, the debt defeasance transactions were singular transactions concerning liabilities created by the taxpayer in raising capital for its business. They were not part of the regular means whereby CPIF obtained returns. Here, in our opinion, there is an important point of distinction. The taxpayer in Orica was not a finance company. The singularity of the transaction it entered into in relation to its debentures was supported in part by that fact.

79. Although a debt defeasance transaction entered into by a finance company may not be a typical and repeated element of the ordinary course of that company's business, it may nevertheless be regarded qualitatively as so related to the ordinary business of the company that gains made from it are to be treated as income according to ordinary concepts. As the learned primary judge put it [at 98 ATC 5024]:

``... The real question in the present case is not directly whether CPIF should, for some statutory purpose, be characterised as `a finance company', (or money-lender) but rather whether the activity which gave rise to the defeasance profit was one done in, to adopt the language of the Lord Justice Clerk in
Californian Copper Syndicate Ltd v Harris (Surveyor of Taxes) (1904) 5 TC 159 at 166 `what is truly the carrying on, or carrying out of a business'.''

(AB1749)

80. There is necessarily an evaluative judgment involved in assessing the connection between the transaction in issue and the ordinary business of the company for the purpose of determining whether the gain made is made in the ordinary course of the company's business. In our opinion his Honour's

ATC 5005

assessment was correct. Given the nature of CPIF's role in the international group, the debt defeasance transactions were sufficiently connected to its ordinary functions of borrowing and lending to justify the treatment of the gains therefrom as income. As to the characterisation of the accounting difference as a profit or gain his Honour distinguished the case of CPIF from that of Orica by saying that in this case the liability was on revenue account. Accepting the application of the observations in Avco Financial Services to the present case and treating the borrowing and repayment of loans as transactions on capital account, the relevant gains and losses can nevertheless be regarded as revenue gains and losses as was said in Coles Myer. The accounts of CPIF reflected, as his Honour pointed out, that a profit had been made when its liability was discharged by payment and the gain was not merely ``an accounting difference''. Therefore, and subject to the observations in these reasons about the characterisation of CPIF's liabilities, the arguments advanced on the notices of contention do not succeed.

Debt defeasance profit as adjusted tainted income

81. Central to the Commissioner's appeals on the debt defeasance issue was the proposition, rejected by his Honour, that the debt defeasance profit was notional assessable income of CPIF by reason of being adjusted tainted income. To establish that the debt defeasance profit was adjusted tainted income the Commissioner relied upon par (j) of s 446(1) and par (k) of that subsection as modified by s 386. That is to say the Commissioner submitted in the alternative that the debt defeasance profit was adjusted tainted income because it was either:

(i) income derived from carrying on a business of trading in tainted assets (446(1)(j)); or
(ii) amounts derived from the disposal of tainted assets (446(1)(k) as modified).

82. The Commissioner argued that Hill J had misapplied par 446(1)(j) by focussing on the question whether CPIF derived the relevant income by trading in tainted assets. The real question was whether the income derived from carrying on a business of trading in tainted assets. The business of CPIF was said, on the facts, to be the composite activity of borrowing by issue of bonds and on-lending at a profit by bills of exchange. These activities were driven by the common objective of providing finance to members of the CPH group at a profit to CPIF. It was sufficient for the application of par 446(1)(j) that the income be derived from a business of trading in tainted assets. The profit or gain from the debt defeasance was so derived whether the tainted assets were the bills of exchange or the bonds or both.

83. For CPH and MLG it was said that to carry on a business of trading in a class of assets requires the business to be involved in buying or manufacturing and selling the assets. Buying without selling is not a business of trading in an asset. The bonds were not assets of CPIF, they were liabilities. The issue of the bonds did not involve trading in them. The discharge of CPIF's obligations under the bonds by EFS pursuant to the assumption agreements did not constitute trading in bonds. And the bills of exchange CPIF purchased were not sold but held to maturity at which time new bills were purchased out of the proceeds of the maturing bills. Such activities had ceased in December 1988. There were no purchases by CPIF of tainted assets.

84. The word ``trade'' as noun and verb appears in several places in the Constitution and in a variety of statutory contexts. Its exegesis in the case law to which we were referred must be considered against the particular context in which it is used. The ordinary meaning of the word as defined in the Shorter Oxford English Dictionary, relevantly for present purposes, is:

``buying and selling or exchange of commodities for profit.''

Some definitions have limited its application to physical assets. But that is, as Dixon J observed in
Bank of New South Wales v The Commonwealth (1948) 76 CLR 1 at 381, a specialised meaning of the word:

``... The present primary meaning is much wider, covering as it does the pursuit of a calling or handicraft, and its history emphasises rather use, regularity and course of conduct.''

The latter observation was made about the word ``trade'' as used in s 92 of the Constitution. The constitutional concept of ``trade'' is necessarily wide. So ``trade and commerce'' in s 92 extends to ``all the commercial dealings and all the accessory methods in fact adopted by Australians to initiate, continue and effectuate the movement

ATC 5006

of things and persons from State to State...'' -
W & A McArthur Ltd v State of Queensland (1920) 28 CLR 530 at 549. Reference was made in argument to these cases and to the constitutional concept of a trading corporation discussed in
Ex parte Western Australian National Football League & Anor (1979) ATPR ¶40-103; (1978-1979) 143 CLR 190. In the end, however, what is involved in this case is a more mundane concept of trade expressed in the collocation ``a business of trading in tainted assets'' in par 446(1)(k). That collocation invites consideration of the necessary subject matter of the trade which must be ``tainted assets'' and which includes bonds and bills of exchange. It applies to those things in their character as assets. A bond will be an asset in the hands of a person to whom it is issued. It is a chose in action. As a chose in action it may be assigned. It can be bought and sold on the open market. But a corporation that raises loan funds by issuing bonds that represent its liabilities is not thereby trading in them. The issue of bonds by CPIF does not support the characterisation of its business as one of trading in them as assets. A company which buys and sells bonds may be said to conduct such a business. It was a fact found by his Honour that upon raising funds through the issue of the bonds, CPIF advanced funds to companies in the Consolidated Press Group as well as purchasing bills of exchange at a discount as part of its financing activities.

85. The Commissioner contended that his Honour focused on the question whether CPIF traded in tainted assets and derived income therefrom rather than the statutory issue, namely whether it carried on a business of trading in tainted assets from which the relevant income was derived. This is not borne out by his Honour's reasons. Having concluded that the debt defeasance profit was ``income derived from carrying on a business'' his Honour posed the next requisite question he had to consider thus [at 98 ATC 5025]:

``... the difficulty which then arises is whether that business is one of `trading in tainted assets', `tainted assets' being defined in s 317.''

Taken as a whole his Honour's reasons indicate that, contrary to the Commissioner's submissions, he identified correctly the issue he was required to address under par 446(1)(j).

86. The Commissioner relied upon the fact that CPIF gave and received cash for bills of exchange. But the bills of exchange were purchased by CPIF as accommodation party under acceptance facilities between CPIL and CPF up to 26 December 1985 and between CPIL(UK) and CPF from 16 December 1985 to 20 December 1988. It held those bills to maturity and purchased new bills out of the proceeds of the maturing bills. It was submitted for CPH and MLG that this could not properly be described as carrying on a business of trading in tainted assets given the absence of any selling. That is not to say such activity does not constitute a business. In
Lend Lease Corporation Ltd v FC of T 90 ATC 4401; (1990) 95 ALR 427 Hill J accepted as ``clearly correct'' a concession made by the taxpayer in that case that where the taxpayer acted as a financier for its group of companies and purchased at a discount securities which it held until maturity, the proceeds on redemption were income in ordinary concepts derived from the carrying on by it of a business of investment whether that business be seen as a separate business or as ancillary to the financing business. Reference was made to
London Australia Investment Co Ltd v FC of T 77 ATC 4398; (1977) 138 CLR 106. There is recognition in the judgments of Gibbs and Jacobs JJ of the distinction between an investment business involving the acquisition of shares for dividend returns and the business of buying and selling shares. In the case before his Honour the business of the taxpayer so far as it related to the acquisition of securities was the acquisition of those securities for the purpose of holding them until maturity and making a profit being a difference between the discounted acquisition price and the face value of the security. That business did not include the acquisition of securities and their sale. The factual situation in relation to CPIF's dealings with bills of exchange does not support the characterisation of its business as trading in tainted assets constituted by the bills of exchange.

87. For these reasons his Honour was correct in his conclusion that the debt defeasance transaction did not generate income derived from carrying on a business of trading in tainted assets.

88. The Commissioner's alternative position was that the debt defeasance profit was an

ATC 5007

amount derived from the disposition of tainted assets within the meaning of par 446(1)(k) as modified by s 386(2). He submitted that the rights that arose to CPIF to have its obligations in relation to the bonds met by EFS were themselves ``tainted assets''. In this respect he relied upon subpar (c)(ii) of the definition of tainted assets in s 317 namely, ``any other asset used solely in carrying on a business''. He also relied upon the definition of ``disposal'' under s 317 which ``in relation to an asset, includes redemption''. The Commissioner submitted that as and when the bonds were redeemed by EFS there was a disposal of a tainted asset. It was submitted for CPH and MLG that when EFS performed its obligations under the assumption arrangements the rights of CPIF might have been discharged and satisfied but were not redeemed. Moreover any disposal of bonds by redemption was from the perspective of the holder of the bonds, not the issuer of the bonds. On this point his Honour said [at 98 ATC 5025]:

``... The debt defeasance arrangement involved no disposal of any asset, tainted or otherwise. All that happened was that for the payment of money CPIF obtained the benefit of an obligation on the part of the assumption party to make payments of money in satisfaction of CPIF's obligation to bondholders for principal and interest and of commission. Although the bonds were capable of falling within the definition of `tainted assets' they were never assets of CPIF. While `disposal' is defined in s 317 to include in relation to an asset the redemption of that asset, the profit made by CPIF did not arise from redemption of an asset of CPIF, but rather satisfaction of a liability of CPIF.''

We respectfully agree with his Honour's reasoning and conclusion about the application of par (k).

Conclusion

89. For the preceding reasons the appeals by the Commissioner and the cross-appeals by CPH and MLG should be dismissed.

THE COURT ORDERS THAT:

For each of the Appeals NG 1176 of 1998 to NG 1183 of 1998:

1. The appeal is dismissed.
2. The cross-appeal is dismissed.
3. The Appellant is to pay the Respondents' costs of the appeal.
4. The Cross-Appellants are to pay the Cross-Respondent's costs of the cross- appeal.

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