Decision impact statement

Virgin Holdings SA v Commissioner of Taxation; Undershaft (No. 1) Limited and Undershaft (No. 2) BV v Commissioner of Taxation

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Court citation:
Virgin Holdings SA v Commissioner of Taxation
[2008] FCA 1503
2008 ATC 20-051
70 ATR 478
Undershaft (No. 1) Ltd (formerly CGNU Holdings (Aust.) Ltd) and Undershaft (No. 2) BV (formerly Norwich Union Overseas Holdings BV) v Commissioner of Taxation
[2009] FCA 41
(2009) 2009 ATC 20-091
175 FCR 150
253 ALR 280
74 ATR 888

Venue: Federal Court of Australia
Venue Reference No: NSD 1149 of 2007, NSD 57 of 2008; NSD 1283 of 2006 and NSD 1282 of 2006
Judge Name: Edmonds J; Lindgren J
Judgment date: 10 October 2008; 3 February 2009
Appeals on foot:
No, Commissioner's appeal to Full Federal Court withdrawn.

Impacted Advice

Relevant Rulings/Determinations:

• TR 2001/12
• TR 2001/13

Subject References:
Income tax
International tax agreements
Double tax agreements (DTAs)
Taxation of capital tax in respect of DTAs entered into before introduction of capital gains tax (CGT) in Australia
Business profits and alienation of property articles
Comity in judicial decision-making

Précis

Outlines the Tax Office's response to two cases which raised the issue of whether Double Tax Agreements entered into prior to the CGT regime in Australia, denied the Commissioner the right to tax capital gains derived in Australia by foreign residents

Decision Outcome

Brief Summary of Facts

In each of the matters, the applicants were foreign resident companies. Virgin Holdings SA was incorporated in Switzerland, Undershaft (No. 1) Limited was incorporated in the United Kingdom and Undershaft (No 2) BV was incorporated in the Netherlands. It was accepted in each case that none of the applicants carried on business through a permanent establishment in Australia.

The Commissioner takes the view in TR 2001/12 that DTAs entered into by Australia prior to the introduction of the comprehensive CGT regime into the Australian income tax legislation in 1985 ("pre-CGT DTAs") do not limit Australia's right to tax capital gains derived by entities that are residents of pre-CGT DTA treaty partners under the comprehensive capital gains tax regime.

The comprehensive capital gains tax regime was introduced into the Australian income tax legislation in 1985, by way of Part IIIA of the Income Tax Assessment Act 1936, and continues in Part 3-1 of the Income Tax Assessment Act 1997.

The DTAs between Australia and Switzerland, Australia and the UK, and Australia and the Netherlands came into force in 1981, 1967 and 1976 respectively and each of those DTAs remained in force at the time of the relevant transactions in each of the matters in the 2004 and 2001 tax years.

Virgin Holdings SA

Virgin Holdings SA was a company resident in Switzerland which was a shareholder in Virgin Blue Holdings Ltd, an Australian resident company. Due to a company group restructure and through a series of transactions including a 1:120 share split, on 4 November, 8 and 12 December 2003 Virgin Holdings disposed of 21,721,626, 7,031,176 and 123,196,853 respectively of its shares in Virgin Blue Holdings Ltd. The Commissioner allowed roll-over relief in respect of the 4 November share disposal. The 8 December disposal was an off-market share buy-back and the Commissioner allowed share buy-back capital losses of $4,208,737 pursuant to Division 16K of the ITAA 97. Inclusive of the amount rolled over from another member of the company group, a capital gain of $196,954,809 for the accounting period in lieu of the year ended 30 June 2004 arose for Virgin Holdings SA as a result of the 12 December 2003 sale.

The Federal Court (Edmonds J) handed down a decision in the Applicant's favour on 10 October 2008. On 31 October 2008 the Commissioner appealed that decision to the Full Federal Court. The appeal has now been withdrawn by the Commissioner.

Undershaft

Undershaft (No 1) was a company resident in the UK and Undershaft (No 2) was a company resident in the Netherlands. As a result of an earlier merger, on 20 December 2000, Undershaft (No 1) disposed of its shares in CGU Insurance Australia Ltd, an Australian resident company, and Undershaft (No 2) disposed of its shares in Norwich Union Australia Ltd, also an Australian resident company. The parties agreed that the sales fell within CGT Event A1 under s104-10 of the ITAA 97 and that a capital gain arose to each of Undershaft (No 1) and (No 2) as a result of those sales. In the year ended 30 June 2001 Undershaft (No 1) made a gain of $273,000,000 and Undershaft (No 2) made a gain of $108,585,000.

The Federal Court (Lindgren J) handed down a decision in the Applicants' favour on 3 February 2009.

Issues decided by the court

Virgin Holdings

1.

CGT amounts are included in "taxes covered" for the purposes of Article 2 of the Swiss DTA where the Swiss DTA was a pre CGT treaty, both as part of "the Australian income tax" in Article 2(1)(a) and alternatively as a "substantially similar tax" for the purposes of Article 2(2);

2.

The CGT amounts are included in "profits of an enterprise" for the purposes of Article 7 of the Swiss DTA; or

3.

The CGT amounts are included in "income from the alienation of capital assets of an enterprise" for the purposes of Article 13(3) of the Swiss DTA;

4.

Accordingly, the CGT amounts are precluded from liability to tax in Australia.

Undershaft (No 1)

1.

Article 5 (Industrial or Commercial Profits Article) of the UK DTA applies to capital gains which are included in assessable income under the ITAA 1997;

2.

The term "Commonwealth income tax" in Article 1(1)(b) (Taxes Covered Article) of the UK DTA includes capital gains;

3.

Although not necessary to decide, in relation to Article 1(2) of the UK DTA, the tax on capital gains, as introduced by Part IIIA of the ITAA 1936, constitutes a "substantially similar tax" to the taxes covered in Article 1(1).

Undershaft (No 2)

1.

Article 7 (Business Profits Article) of the Netherlands DTA applies to capital gains which are included in assessable income under Part 3-1 of the ITAA 1997;

2.

The term "Australian income tax" in Article 2(1)(a) (Taxes Covered Article) of the Netherlands DTA includes capital gains;

3.

Although not necessary to decide, in relation to Article 2(2) of the Netherlands DTA, the tax on capital gains, as introduced by Part IIIA of the ITAA 1936, constitutes a substantially similar tax to the taxes covered in Article 2(1).

4.

Capital gains tax would be covered by the Netherlands Agreement regardless of whether Australia had informed the Netherlands of its introduction (as required by Article 2(2)).

Judicial comity (Undershaft)

This was relevant due to the decision in Virgin Holdings having been handed down in the same court 17 days prior to the hearing in Undershaft.

1.

The principle of judicial comity requires, assuming the case to be indistinguishable, (particularly in this matter concerning interpretation of Commonwealth legislation) that the court follow an earlier decision unless it considers it clearly wrong or plainly wrong.

Tax Office view of Decisions

The Commissioner accepts that with two separate decisions at first instance reaching a common conclusion in relation to substantially common issues, there has now been sufficient clarification of the law.

Accordingly, the Commissioner has withdrawn his appeal to the Full Federal Court in the Virgin Holdings matter. The appeal period in the Undershaft matters expired on 3 March 2009 and the Commissioner has not appealed the decision of Lindgren J in those matters.

The Commissioner will, where appropriate, apply the decisions in respect of similar matters involving entities making taxable capital gains under Part 3-1 of the ITAA 1997 which are residents of countries where a similarly worded DTA signed prior to the introduction of a comprehensive capital gains tax regime in 1985 applies. It means that, under the DTA, the Commissioner is denied the right to include capital gains in the assessable income of residents of these countries that make capital gains in Australia from the sale of similar assets in circumstances covered by the two cases.

It is noted, however, that as Australia has renegotiated a number of the DTAs that were in force in 1985, including those with many of our significant trading partners (e.g. the United States of America, the UK, New Zealand, Canada) these decisions will have a somewhat limited application. As further DTAs are renegotiated, the potential impact of this decision will lessen. Further, the ongoing significance of this issue with respect to the disposal of shares is reduced due to the narrowing of the range of assets held by foreign residents that are subject to CGT following legislative changes enacted by the Tax Laws Amendment (2006 Measures No 4) Act 2006 with effect from 12 December 2006. The direct and indirect interests in real property (including certain options and rights) held by foreign residents, and business assets of a foreign resident's permanent establishment in Australia are subject to the CGT provisions. It is noted that both the remaining pre-CGT tax treaties and those subsequently negotiated generally allocate the right to tax capital profits from the alienation of these types of assets.

In the Undershaft decision, Lindgren J commented, in obiter, at paragraph 46, that "A DTA does not give a Contracting State power to tax ..." However, the Commissioner takes the view that, in certain circumstances - for example a transfer pricing matter in respect of the Associated Enterprises Article - a DTA may apply (refer to the discussion at paragraphs 29-33 of TR 2001/13).

Administrative Treatment

Implications on current Public Rulings & Determinations

TR 2001/12 - Income tax and capital gains tax: capital gains in pre-CGT tax treaties will be withdrawn. TR 2001/13 - Income tax: Interpreting Australia's Double Tax Agreements will be amended, in so far as it refers to TR 2001/12.

Implications on Law Administration Practice Statements

None

Legislative References:
Commonwealth Constitution
55
114

Income Tax Assessment Act 1915 (Cth)
53

Income Tax Assessment Act 1922 (Cth)
16B
17
93

Income Tax Assessment Act 1936 (Cth)
Part IIIA
25A
26
26AAA
36
47
160ZO
167
260

International Tax Agreements Act 1953 (Cth)
3
4
5
11A
11E
Schedule 1
Schedule 10
Schedule 15

Income Tax Assessment Act 1997 (Cth)
Part 3-1
102-5

Case References:

Virgin Holdings and Undershaft

Applicant A v Minister for Immigration and Ethnic Affairs
[1997] HCA 4
190 CLR 225
142 ALR 331

Chong v Commissioner of Taxation
(2000) 101 FCR 134
2000 ATC 4315
44 ATR 295

Commissioner of Taxation v Lamesa Holdings BV
(1997) 77 FCR 597
36 ATR 589
97 ATC 4752

McDermott Industries (Aust) Pty Ltd v Commissioner of Taxation
(2005) 142 FCR 134
2005 ATC 4398
59 ATR 358

Resch v Federal Commissioner of Taxation
(1942) 66 CLR 198
15 ALJ 359
6 ATD 203

South Australia v Commonwealth
(1992) 174 CLR 235
23 ATR 10
92 ATC 4066

Thiel v Federal Commissioner of Taxation
(1990) 171 CLR 338
21 ATR 531
90 ATC 4717


Virgin Holdings

Federal Commissioner of Taxation v Sherritt Gordon Mines Limited
(1977) 137 CLR 612
7 ATR 726
77 ATC 4365

Gadsden v Minister for National Revenue (Tax Review Board)
83 DTC 127

Hastie Group Limited v Commissioner of Taxation
[2008] FCA 444
2008 ATC 20-019
70 ATR 353

Kinsella v Revenue Commissioners
[2007] IEHC 250
10 ITLR 63


Undershaft

Fernando v Commissioner of Police
(1995) 36 NSWLR 567
78 A Crim R 64

La Macchia v Minister for Primary Industries and Energy
(1992) 110 ALR 201

Lamesa Holdings BV v Federal Commissioner of Taxation
(1997) 97 ATC 4229
35 ATR 239

Mutual Pools & Staff Pty Ltd v Commissioner of Taxation (Cth)
(1992) 173 CLR 450
22 ATR 856
92 ATC 4016

R v Dyson
(1997) 68 SASR 156
92 A Crim R 233

R v Franklin
(1979) 22 SASR 101
1 A Crim R 1

Re McKean
(unreported, Federal Court of Australia, 16 April 1996)
BC 9602146

Tillman v Attorney-General for the State of New South Wales
[2007] NSWCA 327
70 NSWLR 448
178 A Crim R 133

TSL v Secretary to the Department of Justice
[2006] VSCA 199
14 VR 109
166 A Crim R 69

Unisys Corporation Inc v Commissioner of Taxation
[2002] NSWSC 1115
2002 ATC 5146
51 ATR 386

Other References:
Vienna Convention on the Law of Treaties
'Agreement between Australia and Switzerland for the Avoidance of Double Taxation with respect to Taxes of Income' entered into force on 13 February 1981
'Agreement between the Government of the Commonwealth of Australia and the Government of the United Kingdom of Great Britain and Northern Ireland for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income and Capital Gains' signed on 7 December 1967
'Agreement between Australia and the Kingdom of the Netherlands for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income' signed on 17 March 1976