Decision impact statement
Commissioner of Taxation v Tasman Group Services Pty Ltd
Court Citation(s):
[2009] FCAFC 148
180 FCR 128
74 ATR 739
2009 ATC 20-138
Venue: Federal Court of Australia
Venue Reference No: 164 of 2008; 165 of 2008
Judge Name: Ryan, Kenny and Stone JJ
Judgment date: 22 October 2009
Appeals on foot:
The taxpayer's application for special leave to appeal to the High Court was refused on 23 April 2010.
Impacted Advice
Relevant Rulings/Determinations:- N/A
Subject References:
debt
commercial debt
forgiveness of debt
CGT asset
necessary connection with Australia
use of debt in carrying on a business through a permanent establishment
Précis
The application of the commercial debt forgiveness provisions in Division 245 of Schedule 2C of the Income Tax Assessment Act 1936 to debts of a resident subsidiary company forgiven by its non-resident parent.
Brief summary of facts
The taxpayer, a wholly owned subsidiary of a Japanese resident company (the parent ), operated an Australian meat processing and exporting business. Between November 1996 and January 1997, three loans were made by the parent to the taxpayer to fund, in part, the acquisition of the business. The business suffered substantial trading losses and subsequent loans were made by the parent to the taxpayer between June 1999 and February 2002 to finance the taxpayer's ongoing operations. Each of the loans was made under a written agreement. The law of Japan was specified as the law governing each loan contract. The loan agreements were prepared and executed by the parent in Japan. Initially, the loan agreements provided for the payment of interest and for withholding tax on the interest payment to be deducted by the taxpayer and paid to the taxation authority. From June 2000, the parent agreed to exempt the taxpayer from interest on the earlier loans and subsequent loans were interest free. Amending agreements were made to extend the time of repayment of the loans, which were all eventually repayable on 31 March 2002.
From November 1996, three executives from the parent were assigned to the taxpayer to take an active role in the day to day business operations and management of the taxpayer. They occupied offices at the taxpayer's head office at Altona in Victoria. The executives remained employees of the parent, but two were appointed as directors of the taxpayer. The taxpayer paid a fee to the parent under a formal agreement for the services of the executives. Decisions concerning matters such as capital expenditure, payroll, staffing levels, repairs and maintenance and export marketing were subject to approval by the parent, based on submissions and recommendations by the three executives.
After the acquisition of the business by the taxpayer various proposals were discussed between the taxpayer's bankers, the ANZ, and the parent. The ANZ had initially requested that the parent loans be subordinated, but accepted instead legally enforceable undertakings given by the parent that the loans would not be withdrawn without ANZ's consent. Based on that undertaking, the ANZ agreed to treat the loans as shareholder funds for lending covenant purposes.
In April 1999, the taxpayer's auditors required a letter of comfort from the parent before they would sign the accounts. The parent provided letters of comfort on 25 May 1999 and again on 20 November 2001. The letters of comfort provided that the parent would not call for repayment of the loans prior to 30 November 2001 and 30 September 2003 respectively, and that it would continue to provide ongoing financial support to enable the taxpayer to meet its liabilities as and when they fell due.
Pursuant to an agreement dated 27 February 2002, the parent sold its shares in the taxpayer to Tasman Group Holding Pty Ltd. It was a term of the sale agreement that the parent was to ensure "no amount of financial indebtedness exists." Financial indebtedness was defined to include the amount owed by the taxpayer to the parent. Minutes of a meeting of directors of the taxpayer held on 1 March 2002 recorded that the parent had agreed to cancel the loans and, following completion of the sale, entries in the taxpayer's accounts recorded a forgiveness of the amount owing to the parent of $118,696,459.
At first instance, Heerey J held that the amounts owed under the loans were debts, Division 245 commercial debts and that they had been forgiven. However, Heerey J also held that the debts had been "used" by the parent in carrying on a business through a permanent establishment in Australia. That business was said by his Honour to have been carried on by the parent through its wholly owned subsidiary, the taxpayer, at the head office and plant at Altona and at other plants at Longford in Tasmania and on King Island. In that case, in working out the notional value of the debt forgiven for the purposes of Division 245 of Schedule 2C to the Income Tax Assessment Act 1936, the assumption of solvency in ss.245-55(2)(a) and (3)(a)(i) did not apply.
The Commissioner appealed the last aspect of the judgment of Heerey J. The taxpayer cross-appealed his Honour's conclusion that the loans were debts, division 245 commercial debts and that they had been forgiven.
Issues decided by the court
The amounts owed by the taxpayer under the loans from the parent were debts within the meaning of s.245-15. The extension of time for repayment of the loans and the covenants in the letters of comfort altered the time for performance, but did not relieve the taxpayer of the legal obligation to repay.
The debts were commercial debts within the meaning of s.245-25 because interest initially payable on the loans by the taxpayer was an allowable deduction and had interest been payable subsequently from June 2000, it would also have been an allowable deduction. The taxpayer's submission that any interest payable on the acquisition and subsequent loans was, or would have been, an outgoing of capital or of a capital nature was rejected. Instead, the Full Federal Court held that the taxpayer's purpose of entering into the loans is determinative of the nature of the outgoing. Here the evidence established that the taxpayer entered into the loans for the purpose of earning assessable income, albeit that it was not successful in doing so.
Pursuant to s.245-35(1), the taxpayer's obligation to pay the debt was released or waived, or otherwise extinguished. Contrary to the taxpayer's submission, the Full Federal Court held that there was no requirement that the debt be expressly forgiven. The evidence established that there was a clear intention that the debt be waived. Both the parent and the taxpayer were parties to the share sale agreement, which provided that there be "no amount of financial indebtedness" on the completion date, the parent had agreed to cancel all of the loans and the taxpayer's financial records recorded the debt forgiveness. Moreover, waiver by implication is permissible under Japanese law, which governed each loan contract.
The forgiveness of the debt did not have the necessary connection with Australia as required by s.245-55(4)(a)(ii). Contrary to what Heerey J held below, the Full Federal Court found that the [meat processing and exporting] business was that of the taxpayer, not the parent. It was the Commissioner's submission that the business conducted by the parent in Australia was the supply of executives to the taxpayer, and that the permanent establishment for that business was at the head office at Altona where accommodation was provided to the executives. The taxpayer submitted that the parent carried on business through a permanent establishment in Australia as a holding company, managing and financing its subsidiary in Australia. On either characterisation, the Full Federal Court did not accept that the parent carried on a business through a permanent establishment in Australia and said that the proper question was how the debts were used by the parent. Consistent with the Commissioner's argument that no use of the debt in a business carried on by the parent at a permanent establishment in Australia arises on the facts, the Full Federal Court found that the use of the debts consisted of receiving interest payments or debiting the taxpayer in respect of its liability and extending from time to time the date for repayment of principal and interest. That use occurred in Japan and not Australia. Consequently, the assumption of solvency applied in calculating the notional value of debt forgiven by the parent.
ATO view of Decision
The decision is consistent with the Commissioner's view that amounts owed under the loans were commercial debts that were forgiven by the parent. It is true that the conclusion of the Full Federal Court that the parent did not carry on a business through a permanent establishment in Australia is inconsistent with the concession made by the Commissioner that the parent's business in Australia was the supply of executives at a permanent establishment at the taxpayer's head office. However, the Commissioner agrees with the finding of the Full Federal Court that on the facts of this particular case the parent did not use the debts in carrying on any business through a permanent establishment in Australia.
The assumption of solvency in the commercial debt forgiveness provisions has the effect that the amount to be treated as forgiven is, broadly speaking, the full (nominal) amount of the debt. However, s.245-55(4) displaces the assumption in certain cases where the debt, from the point of view of a non-resident creditor, has the necessary connection with Australia. This ensures a fair outcome overall, after the Australian CGT position of the creditor is taken into account. In this case the debts did not have the necessary connection with Australia, the consequence of which is that the assumption of solvency applied in calculating the notional value of the debts forgiven.
Subparagraph 245-55(4)(a)(ii) was amended so as to apply to CGT events happening on or after 12 December 2006, by substituting "that was taxable Australian property" for "having the necessary connection with Australia". Pursuant to Item 3 of the table at s.855-15 of the Income Tax Assessment Act 1997 taxable Australian property includes a CGT asset "used at any time in carrying on a business through a permanent establishment (within the meaning of section 23AH of the Income Tax Assessment Act 1936) in Australia". Notwithstanding the amendment to s.245-55(4)(a)(ii), the decision of the Full Federal Court will continue to be relevant to the application of the commercial debt forgiveness provisions, including in the case of non-arm's length debts forgiven by non-resident creditors.
Administrative Treatment
List of Rulings and Determinations Affected
None
Implications on current Public Rulings & Determinations
None
Implications on Law Administration Practice Statements
None
Legislative References:
Income Tax Assessment Act 1936
6
Div. 245 of Sch. 2C
Income Tax Assessment Act 1997
104-25
108-5
136-25
Case References:
Emu Bay Railway Co Ltd v Federal Commissioner of Taxation
[1944] HCA 28
71 CLR 596
Spassked Pty Ltd v Commissioner of Taxation
[2003] FCAFC 282
2003 ATC 5099
54 ATR 546
GP International Pipecoaters Proprietary Limited v Federal Commissioner of Taxation
[1990] HCA 25
170 CLR 124
21 ATR 1
90 ATC 4413
Craine v The Colonial Mutual Fire Insurance Company Limited
[1920] HCA 64
28 CLR 305
Grundt v The Great Boulder Proprietary Gold Mines Limited
(1937) 59 CLR 641
[1937] HCA 58
The Commonwealth of Australia v Verwayen
(1990) 170 CLR 394
Hope v The Council of the City of Bathurst
[1980] HCA 16
144 CLR 1
12 ATR 231
80 ATC 4386