Decision impact statement
Commissioner of Taxation v Ashwick (Qld) No 127 Pty Ltd & Ors
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Court citation:
[2011] FCAFC 49
2011 ATC 20-255
Venue: Federal Court of Australia
Venue Reference No: VID 034-047 of 2010
Judge Name: Bennett, Middleton and Edmonds JJ
Judgment date: 8 April 2011
Appeals on foot: No.
Impacted Advice
Relevant Rulings/Determinations:
Subject References:
Income tax
Intra-grouploans
Bad debts
Interest expense
Incurred in carrying on a business
Part IVA
Scheme
Tax benefit
Purpose
Précis
Outlines the ATO approach to this case which concerned whether multiple layers of deductions are allowable for bad debts, interest on borrowings and transferred tax losses, in relation to chains of loans between related companies within the Foster's Group.
Brief summary of facts
The taxpayers were members of the Foster's Group, which was headed by Foster's Group Ltd (FGL). Among the group's diverse range of business activities was a financial services business conducted by subsidiaries collectively known as the Finance Group, which included EFGA (the holding company), ELFIC and EFGS. From late 1984, the funding of the Finance Group was organised through EFGA, which in turn lent to its subsidiaries, including ELFIC and EFGS.
The fortunes of the Finance Group deteriorated dramatically as a result of the stock market crash in 1987 and the introduction of capital adequacy guidelines by the Reserve Bank of Australia. While the Finance Group continued to grow during the financial year ended 30 June 1988, ELFIC and EFGS suffered operating losses that year and in subsequent years and in June 1989 required additional capital from EFGA in order to report positive net assets and retain the licences necessary to operate their businesses.
FGL's own fortunes also deteriorated dramatically when Harlin Holdings Pty Ltd launched a takeover bid for the Fosters' Group in 1989.
In March 1990, FGL announced that it would focus solely on its brewing business and divest itself of all its other businesses, including those conducted by the Finance Group. From that point on, EFGA focused on selling its assets and recovering loans which it had made to external borrowers.
After June 1990, following a downgrade in Foster's and EFGA's credit ratings, external lenders increasingly withdrew their funding from EFGA and replacement funding was provided by the Foster's Group through two chains of loans. The first chain began with a loan to EFGA from Amayana, which in turn borrowed from FBG Treasury (Aust), which conducted the Foster's Group's treasury activities and was the vehicle through which the banks lent to the Foster's Group. The second chain began with a loan to EFGA from EFG Treasury, which in turn borrowed from Foster's Group Limited (FGL).
From 1 September 1990, EFGA lent to ELFIC and EFGS and charged them the same rate it was charged by internal lenders, including FGL, EFGT and Amayana. The continued debt funding was intended to allow an orderly realisation of the residual assets of the Finance Group. As their assets declined so did the capacity of ELFIC, EFGS and EFGA to satisfy their internal loan obligations.
Another reason for the debt funding was the need to address potential claims by litigation creditors. In early 1991, EFGT was introduced into the funding structure as part of a security arrangement that was intended to ensure FGL would have priority over litigation creditors. However, the Amayana loan to EFGA was not included in the security arrangement.
In April 1991, the Finance Group made a request to the Foster's Group for $400 million in interest free funding to eliminate a budgeted loss for the 1992 financial year and prevent external auditors from requiring additional provisioning of $60 million in the Finance Group accounts. The proposal was rejected by the board of FGL.
As at 30 June 1991, the Finance Group on a consolidated basis had a deficiency in shareholders' funds of around $194 million.
In early 1998, a review was conducted to assess the prospects of recovering debts owed within the group which resulted in a recommendation that substantial amounts be written off as bad debts. Various members of the group (EFGA, Amayana, EFGT and FGL) subsequently claimed deductions of approximately $2.4 billion for unpaid principal and/or interest on loans made to other members of the group which were written off as bad debts. Deductions of almost $450 million were also claimed by certain members (EFGA, EFGT, EFGS, ELFIC and Amayana) in respect of interest on borrowings from other members of the group. Other members of the group (Ashwick, Nexday and EFGI) claimed deductions for losses transferred to them by the members who had claimed the bad debt and interest deductions.
The Commissioner issued amended assessments to the various members of the group denying the deductions claimed under s.8-1 or s.25-35 of the ITAA 1997. Alternatively, he determined that Part IVA applied to deny the deductions.
The taxpayers objected to the assessments, the Commissioner disallowed the objections and the taxpayers appealed to the Federal Court. At first instance, Ryan J held that EFGA and EFGT operated businesses of lending money and therefore deductions were available under s.25-35 for the whole of the amounts they had written off, but as FGL and Amayana had not been carrying on businesses of lending money the bad debts were only deductible to the extent that they contained a component representing unpaid interest. The interest deductions claimed were allowed and the bad debts, when written off, were allowable as transferable tax losses. Ryan J also held that Part IVA did not apply to cancel the deductions in respect of the continued charging of interest. (See [2009] FCA 1388)
The Full Federal Court held that the primary judge did not err in respect of any of the major issues and dismissed the Commissioner's appeals.
Issues decided by the court or tribunal
The primary questions at issue before the Full Federal Court were:
1. Whether bad debts of $1,202,441,116 and $100,009,232 written off by EFGA in the 1998 income year in respect of loans to ELFIC and EFGS were deductible under s.25-35(1)(b) of the ITAA 1997; and in particular:
- (i)
- whether, after January 1990, it conducted a business of lending money;
- (ii)
- alternatively, whether money lent by it after January 1990 was money lent in the ordinary course of its business of lending money.
2. Whether bad debts of $525,260,163 and $133,165,341 written off by EFGT and Amayana (in respect of unpaid interest on loans to EFGA) and of $401,058,393 by FGL (in respect of unpaid interest on loans to EFGT) in the 1998 income year were deductible under s.25-35(1)(a) of the ITAA 1997;
3. Whether interest expenses incurred by EFGT ($47,514,675), Amayana ($16,875,354), EFGA ($82,681,730), ELFIC ($294,850,133) and EFGS ($6,804,054)were deductible under s.8-1 of the ITAA 1997; and
4. Whether the Commissioner was entitled to make the determinations he did under Part IVA of the ITAA 1936 in respect of the continued charging of interest.
Edmonds J, with whom Bennett and Middleton JJ agreed, held that unpaid principal and interest written off as bad were allowable deductions, and that Part IVA did not apply.
1. Deductibility of bad debts under s.25-35(1)(b)
Edmonds J agreed with the primary judge that EFGA was entitled to a deduction under s.25-35(1) (b) of the ITAA 1997 for the amounts of the debts owing by ELFIC and EFGS that were written off by EFGA as bad in the 1998 year of income. Edmonds J held that EFGA continued to carry on a business of lending money after 1990, and that the loans made by EFGA to each of ELFIC and EFGA after 1990 were made in the ordinary course of that business, notwithstanding that its object in doing so was to wind up or discontinue that business. His Honour found that Ryan J had correctly considered the nature of EFGA's business activities after 1990 in the context of the economic and other external difficulties which adversely impacted upon the business it had conducted since 1985. Edmonds J rejected at [40] the contention that the internal financier activities were confined to serving the purposes of its parent company.
2. Deductibility of bad debts under s.25-35(1)(a)
Edmonds J agreed with the primary judge that FGL, Amayana and EFGT were entitled to the deductions claimed. His Honour concluded that there was no evidence to support the Commissioner's submission that the taxpayers had no real expectation that interest would be paid on the loans they made. His Honour also rejected the Commissioner's argument that as the taxpayers did not carry on a business of lending money, they should have accounted for the interest on a cash basis. Edmonds J held that there was no dispute that the taxpayers carried on a business and that the loans were made in the course of those businesses. Further, having regard to basic accounting principles, the interest was correctly returnable on an accruals basis.
3. Deductibility of interest expenses under s.8-1(1)
Edmonds J agreed with the primary judge's conclusion that the interest expenses claimed by EFGA, EFGT, ELFIC, EFGS and Amayana were incurred in carrying on a business for the purposes of gaining or producing assessable income and therefore deductible under s.8-1(1). His Honour found that there is no 'dichotomy in point of principle' between intra-group arrangements with no external aspect and transactions by parties dealing with each other at arm's length. The Court decided that the cases of Ure, Fletcher and Spassked, which were relied upon by the Commissioner, bear no correlation to the facts in this case. Further, there was no need to go beyond "the obvious commercial explanation" for incurring the interest by having regard to indirect objects or motives or subjective purposes. Edmonds J found that the explanation as to why the interest expense exceeded income derived arose due to the adverse economic factors affecting their business at the relevant time and not the independent pursuit of some objective other than producing assessable income.
His Honour also rejected the Commissioner's submission that, like the loans in Macquarie Finance, the loans in this case had features of permanent capital, rather than debt. In addition, the loans in relation to the post-1990 activities could be characterised in the same way as the loans in relation to the pre-1990 activities. Edmonds J stated that it "will be a rare case where interest incurred by a company in raising money which it uses as capital or working capital in the course of its business is found to be of a capital nature".
It followed that the losses were available to be transferred to Ashwick, Nexday and EFGI and were allowable deductions to those taxpayers.
4. Part IVA
Edmonds J disagreed with the primary judge's findings that there was no scheme and that the taxpayers did not obtain any tax benefit in connection with the schemes identified by the Commissioner. His Honour accepted the view that the existence of an activity in the scheme at an earlier point in time to when the taxpayer entered into the scheme may entitle the Commissioner to trigger the application of Part IVA. His Honour found that the counterfactuals relied on by the Commissioner did not constitute a reasonable expectation as to what might have taken place if the scheme had not been entered into.
The Full Court in Ashwick (at para [153] (4) & (6)) expressed the same view as the Court in Trail Bros (at paras [44] & [52]) and AXA (at paras 131-133) that an element of the scheme may form part of an alternative postulate. On the other hand, there are a number of passages in Lenzo that suggest a different view, that is, that an element of the scheme may not form part of an alternative postulate: see, for example, paragraphs [121], [130] and [136].
Although Edmonds J identified a scheme in Ashwick, his Honour held that, having regard to the matters in s.177D (b), it could not be concluded that any person who entered into or carried out the scheme did so for the sole or dominant purpose of enabling any of the taxpayers to obtain a tax benefit. Rather, Edmonds J found that the dominant purpose was re-financing for the purpose of asset protection, not tax minimisation.
ATO view of Decision
The ATO has not appealed against the Full Federal Court's decision.
This case turns very much on its own facts and the findings made by the Federal Court. The ATO accepts the view that what is or is not in the ordinary course of a taxpayer's business of lending money must be determined by reference to the context in which the business was carried on by the taxpayer.
It is noted that the tax consolidation company group provisions disregard transactions, including loans, between entities within the company group. Although the case is in respect of related party financing prior to the introduction of the tax consolidation company group regime, the policy implications of the decision on post tax consolidation choices by both domestic and foreign based groups are being examined.
In relation to the application of Part IVA, the possible inconsistency in the Full Federal Court between Lenzo on the one hand and Trail Bros and Ashwick on the other as to whether the allowable deduction (if any) identified in the alternative postulate has to be of the same kind or character as that allowable (but for Part IVA) under the scheme, creates some uncertainty for both taxpayers and the Commissioner.
The Commissioner will take all decisions of the High Court and Federal Court into account in applying Part IVA to the particular facts of cases. The Commissioner notes however the weight of authority now provided by the judgments in Trail Bros, AXA and Ashwick on the interpretation of s.177C (1).
Administrative Treatment
Implications for ATO precedential documents (Public Rulings & Determinations etc)
None.
Implications for Law Administration Practice Statements
None.
Legislative References:
Income Tax Assessment Act 1997
8-1
25-35
Income Tax Assessment Act 1936
Part IVA
Case References:
Australian National Hotels Ltd v Federal Commissioner of Taxation
(1988) 19 FCR 234
19 ATR 1575
88 ATC 4627
British American Tobacco Services Limited v Federal Commissioner of Taxation
(2010) 189 FCR 151
[2010] FCAFC 130
2010 ATC 20-222
Commissioner of Inland Revenue v The National Bank of New Zealand
(1976) 2 NZTC 61,150
Commissioner of Taxation v AXA Asia Pacific Holdings Ltd
[2010] FCAFC 134
2010 ATC 20-224
Commissioner of Taxation v Bivona Pty Ltd
(1990) 21 FCR 562
90 ATC 4168
21 ATR 151
Commissioner of Taxation v EA Marr & Sons (Sales) Ltd
(1984) 2 FCR 326
84 ATC 4580
15 ATR 879
Commissioner of Taxation v Hart
(2004) 217 CLR 216
55 ATR 712
2004 ATC 4599
Commissioner of Taxation v Trail Bros Steel & Plastics Pty Ltd
[2010] FCAFC 94
2010 ATC 20-198
79 ATR 780
Commissioner of Taxation v Unilever Australia Securities Limited
(1995) 56 FCR 152
30 ATR 134
95 ATC 4117
Commissioner of Taxes (SA) v Executor Trustee and Agency Co of South Australia Ltd
(1938) 63 CLR 108
Commonwealth of Taxation v Roberts and Smith
(1992) 37 FCR 246
23 ATR 494
92 ATC 4380
CPH Property Pty Ltd v Federal Commissioner of Taxation
(1998) 88 FCR 21
40 ATR 151
98 ATC 4983
Favaro v Federal Commissioner of Taxation
(1996) 34 ATR 1
96 ATC 4975
Federal Commissioner of Taxation v BHP Billiton Finance Ltd
(2010) 182 FCR 526
[2010] FCAFC 25
2010 ATC 20-169
76 ATR 472
Federal Commissioner of Taxation v Lenzo
(2008) 167 FCR 255
2008 ATC 20-014
71 ATR 511
Federal Commissioner of Taxation v National Commercial Banking Corporation of Australia Ltd
(1983) 50 ALR 322
72 FLR 116
15 ATR 21
83 ATC 4715
Federal Commissioner of Taxation v Tasman Group Services Pty Ltd
(2009) 180 FCR 128
[2009] FCAC 148
2009 ATC 20-138
74 ATR 739
Fletcher v Federal Commissioner of Taxation
(1991) 173 CLR 1
22 ATR 613
91 ATC 4950
[1991] HCA 42
GP International Pipecoaters Pty Ltd v Federal Commissioner of Taxation
(1990) 170 CLR 124
21 ATR 1
90 ATC 4413
[1990] HCA 25
Hallstroms Pty Ltd v Federal Commissioner of Taxation
(1946) 72 CLR 634
Kidston Goldmines Limited v Commissioner of Taxation
(1991) 30 FCR 77
22 ATR 168
91 ATC 4538
Levin & Co Ltd v Commissioner of Inland Revenue
[1963] NZLR 801
Macquarie Finance Ltd v Commissioner of Taxation
(2004) 210 ALR 508
[2004] FCA 1170
57 ATR 115
2004 ATC 4866
Macquarie Finance Ltd v Commissioner of Taxation
(2005) 146 FCR 77
[2005] FCAFC 20
2005 ATC 4829
61 ATR 1
Magna Alloys & Research Pty Ltd v Federal Commissioner of Taxation
(1980) 33 ALR 213
11 ATR 276
80 ATC 4542
[1980] FCA 150
Spassked Pty Ltd v Commissioner of Taxation
(2004) 136 FCR 441
2003 ATC 5099
54 ATR 546
St George Bank Ltd v Federal Commissioner of Taxation
(2009) 176 FCR 424
[2009] FCAFC 62
2009 ATC 20-103
73 ATR 148
St George Bank v Commissioner of Taxation
(2008) 69 ATR 634
2008 ATC 20-018
Steele v Deputy Commissioner of Taxation
(1999) 197 CLR 459
41 ATR 139
99 ATC 4242
[1999] HCA 7
Texas Company (Australasia) Ltd v Federal Commissioner of Taxation
(1940) 63 CLR 382
Ure v Federal Commissioner of Taxation
(1981) 50 FLR 219
11 ATR 484
81 ATC 4100
[1981] FCA 9