Decision impact statement

Noza Holdings Pty Ltd and Ors v Federal Commissioner of Taxation; Federal Commissioner of Taxation v Noza Holdings Pty Ltd

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Court Citation(s):
First Instance
[2011] FCA 46 (First Instance)
2011 ATC 20-241
82 ATR 338
Appeal
[2012] FCAFC 43
2012 ATC 20-313
82 ATR 567
(2012) 201 FCR 445

Venue: Federal Court of Australia
Venue Reference No: VID 758-763, VID 764 & VID 908 of 2009 (First Instance); VID 195-198 & VID 200-201 of 2011 (Appeal)
Judge Name: Gordon J (First Instance); Edmonds, Jessup and Robertson JJ (Appeal)
Judgment date: 4 February 2011 (Federal Court Orders); 28 March 2012 (Full Federal Court Orders)
Appeals on foot: No.
Decision Outcome: Part favourable

Impacted Advice

Relevant Rulings/Determinations:

• TD 2009/21

Subject References:
declaration of dividend
payment of dividend
operation of subsection 254V(2) of the Corporations Act 2001 (Cth) ('the Corporations Act')
validity of dividend where payment is in breach of provisions of the Corporations Act
deriving income from a foreign source
appropriate time to consider expectation as to derivation of income
whether scheme entered into for the dominant purpose of a tax benefit
withholding tax and Part IVA
dividend withholding tax

Précis

Outlines the ATO's response to this case which primarily concerned the allowablity of a section 25-90 deduction in respect of an arrangement which utilised redeemable preference shares as a means of financing.

Brief summary of facts

1. In 2001, ITW Inc and its wholly owned subsidiaries (collectively the ITW Group), operated some 600 decentralised businesses in over 40 countries, principally concerned with the manufacture and sale of a wide range of consumer and industrial products. At that time, the ITW Group's annual revenues exceeded US$9 billion, approximately two thirds of which was derived from the ITW Group's US operations.

2. In 2001, the ITW Group entered into a series of transactions designed to centralise ownership of its customer based intangibles and crystallise their value, thereby facilitating any future legal action for their protection and giving rise to state tax savings in the US. This involved the creation of various royalty income streams and their transfer for value between companies in the ITW Group (including via two Australian entities, CSA Pty Ltd (" CSA ") and ITW AFC Pty Ltd (" AFC ")).

3. The transactions were initially envisaged to be tax neutral from an Australian point of view but the final implementation of the transactions was altered from the original design after the last minute identification of a US foreign exchange reporting issue.

Final implementation of the Royalty Income Stream transfer

4. CSFI LLC (" CSFI "), a Delaware company, subscribed for redeemable preference shares issued by CSA in exchange for a $US1 billion demand note. Under the terms of the CSA redeemable preference shares, an obligation arose for CSA to pay CSFI a dividend every year until the stock was redeemed subject to sufficient available profits. Any unpaid dividend would be carried forward and a default dividend would also accrue as a result.

5. CSA endorsed that $US1 billion demand note to AFC in exchange for redeemable preference shares issued by AFC. Under the terms of the AFC redeemable preference shares, an obligation arose for AFC to pay CSA a dividend every year on similar terms to the CSA redeemable preference shares issued to CSFI.

6. CSFI transferred the royalty income streams to AFC in exchange for AFC endorsing the $1 billion demand note back to it and also issuing a $US 3 billion purchase note to it.

7. AFC then transferred the royalty income streams to SGTS Inc (" SGTS "), a Delaware company, in exchange for SGTS assuming AFC's obligations under the $US3 billion purchase note and issuing preferred stock to AFC. Under the terms of the SGTS preferred stock, an obligation arose for SGTS to pay AFC a dividend every year until the stock was redeemed, subject to sufficient 'accumulated earnings'. Any unpaid dividend would be carried forward and an interest charge would also accrue as a result.

Dividends declared and paid on the Preferred Stock and Redeemable Preference Shares

8. In the 2002 income year, no dividend was declared or paid by SGTS to AFC, by AFC to CSA, or by CSA to CSFI.

9. On 1 December 2002 (i.e. the commencement of a substituted 2003 income year), Noza Holdings Pty Ltd (" Noza ") became the head entity of a Multiple Entry Consolidated group pursuant to Division 719 of Part 3-90 of the Income Tax Assessment Act 1997 (" the ITAA97 "). CSA and AFC were part of the consolidated group.

10. On 14 November 2003 (i.e. during the substituted 2003 income year):

•

SGTS and AFC entered into a Dividend Distribution Agreement (" the DDA "), governed under the Delaware General Corporations Law (" the DGCL "), such that, in lieu of a cash, SGTS issued a promissory note to AFC, payable on 24 November 2003, in the amount of $222,655,981 in satisfaction of all dividends and default dividends accrued for the 2002 and 2003 income years. Mr Sutherland executed the DDA and on behalf of both entities and also signed the promissory note as President of SGTS. SGTS did not have sufficient accumulated earnings to pay a dividend of $222,655,981;

•

the directors of AFC held a meeting to accept payment in satisfaction of SGTS' dividend obligations for the 2002 and 2003 income years in the form of a promissory note and further resolved that a dividend of $222,655,981 be declared, payable out of the profits of the company, and be paid to CSA by endorsing the promissory note in favour of it. Mr Sutherland made the resolution; and

•

the directors of CSA also held a meeting to accept payment in satisfaction of AFC's dividend obligations for the 2002 and 2003 income years in the form of a promissory note and further resolved to pay a dividend of $222,655,981 to CSFI by declaring that the dividend be payable out of the profits of the company and by endorsing the promissory note in favour of CSFI. Mr Sutherland also made that resolution.

11. Apart from the promissory note, the CSA accounts showed a profit of $3,571,819 for the 2003 income year.

12. On 24 November 2003, the promissory note was settled in full via wire transfer of cash from SGTS to CSFI.

13. No dividend was declared or paid by SGTS to AFC, by AFC to CSA, or by CSA to CSFI in the 2004 or 2005 income years.

Withholding Tax

14. Due to changes brought in from 1 July 2003 via the Protocol amending the US Double Tax Agreement (DTA) which resulted in the payment being subject to the Dividend Article in the US DTA, no Withholding Tax was payable on the amount of $222,655,981 when declared by CSA to CSFI on 14 November 2003 or when paid by settlement of the Promissory Note on 24 November 2003.

15. The International Tax Agreements Act 1953 was subsequently amended with the changes having been announced on 11 September 2003. As a result, a dividend paid by CSA to CSFI on or after 5 December 2003 would have been subject to the Interest Article in the US DTA rather than the Dividend Article and therefore subject to Withholding Tax.

Section 25-90 issues decided by the Full Court

The Full Court found that, having regard to the terms of the CSA redeemable preference shares, a deduction was available to Noza, as the relevant taxpayer, in the 2003 income year when the dividend was declared and/or paid by CSA to CSFI. The Full Court also upheld the finding of Gordon J below that only part of the amount paid by CSA to CSFI, i.e. an amount of $170,983,354, was allowable to Noza, as the relevant taxpayer, in the 2003 income year. This was because the balance of the payment was not "interest, an amount in the nature of interest or an other amount that is calculated by reference to the time value of money" for the purposes of subparagraph 820-40(1)(a)(i) of the ITAA97.

Specifically, in respect of whether a loss or outgoing was incurred by Noza, the Full Court found that:

•

read in context, the terms of the AFC and CSA redeemable preference shares made it clear that a shareholder's entitlement to receive a dividend is out of the profits of the respective company;

•

on a proper construction of the terms of the AFC and CSA redeemable preference shares, a shareholder had no entitlement to a dividend and the respective company had no obligation to pay it, until a declaration has been made by the directors of the respective company;

•

this case was distinguishable from the circumstances of Commissioner of Taxation v Australian Guarantee Corporation Ltd [1984] FCA 240; (1984) 2 FCR 483 because the incurrence of the obligation here was subject to conditions concerning profitability and a resolution of the directors, and those conditions went to the existence of the entitlement and not merely to the time of payment;

•

the liability must exist during the relevant year and if there is no such liability, it does not matter how likely or certain it is that the liability will come into existence in a future year;

•

Noza incurred a liability when CSA declared a dividend to CSFI because of the language of subsection 254V(2) of the Corporations Act which created a debt at the time of declaration;

•

although the resolution made by CSA's directors stated that the dividend was to "be declared payable out of profits", that wording did not express the existence of sufficient profit as a condition of the validity of the declaration. The wording was merely descriptive; and

•

alternatively, even if the debt created by declaration was invalidly created, it was at best voidable and the consequences for payment of such a dividend were affected by section 256D of the Corporations Act. In the absence of any action by a shareholder or creditor of CSA to declare the dividend void, CSA was definitely committed and completely subjected to paying the dividend.

•

alternatively, the primary judge was correct in finding that a dividend paid in contravention of the DGCL was neither void nor invalid and that the promissory note was therefore enforceable in the hands of each of AFC, CSA and CSFI and CSA therefore incurred a liability when it endorsed the promissory note in favour of CSFI to pay the dividend.

In respect of whether the loss or outgoing incurred by Noza was incurred in deriving income from a foreign source, the Full Court found that:

•

the promissory note issued by SGTS to AFC was enforceable in the hands of AFC such that it was money or money's worth;

•

the word 'income' in section 25-90 of the ITAA97 is a reference to income at general law and the test is therefore conducted by reference to the character of the receipt in the hands of the recipient;

•

AFC derived a gain from property upon receipt of the promissory note under the principles enunciated in McNeil;

•

alternatively, even when viewed from the perspective of the source or account from which the corporate distribution was made, SGTS paid the dividend out of 'surplus' (amounts received on the issue of shares over the par value of those shares) which was not a capital account; and

•

further, there was nothing put forward by the Commissioner to warrant a review that AFC did not at least have an expectation to income from SGTS at the time it incurred the relevant outgoing.

Part IVA issues decided at first instance

The Commissioner did not appeal Gordon J's decision below in respect of the applicability of Part IVA to the obtaining of the section 25-90 deduction.

Her Honour had concluded below that there was a scheme within the meaning of section 177A of the Income Tax Assessment Act 1936 ("the ITAA36") by way of which Noza had obtained a tax benefit. Her Honour also concluded that the exclusion in subparagraph 177C(2)(b)(i) of the ITAA36 was not engaged because the allowance of the deduction could not be said to be attributable to the making of the election to consolidate.

However, her Honour also concluded below that, based on the facts and circumstances of the case, the dominant purpose of the scheme entered into was not to obtain a tax benefit but to address the foreign exchange reporting issue identified just before the implementation of the transfer of the royalty income streams was to occur.

The Commissioner also did not appeal Gordon J's findings below in respect of the applicability of Part IVA to the Withholding Tax issue.

Her Honour had concluded below that Part IVA could not apply as there was no tax benefit since at both the time the scheme was entered into (i.e. the payment of $222,655,981 on 14 November 2003) and at the time the amount was paid (i.e. the settlement of the Promissory Note on 24 November 2003), no Withholding Tax was payable under the US DTA. For completeness, her Honour had also found that if there was a tax benefit, the dominant purpose of the scheme entered into was to satisfy the obligations that arose under the terms of the CSA preference shares.

ATO view of the section 25-90 issues decided by the Full Court

Section 25-90 of the ITAA97 allows an Australian resident taxpayer a deduction for a loss or outgoing that is a particular type of 'cost' in relation to a debt interest and which is incurred in deriving non-assessable non-exempt dividend income from a non-resident company, in which the taxpayer has at least a ten percent shareholding.

The Full Court found that an amount had been incurred for the purposes of section 25-90 of the ITAA97 when the dividend was declared by CSA to CSFI. In reaching this conclusion, the Full Court considered that the liability must exist during the relevant income year and, if there is no such liability, it does not matter how likely or certain it is that the liability will come into existence in a future income year. The Full Court applied, by analogy, the principles developed in relation to subsection 51(1) of the ITAA36 and section 8 1 of the ITAA97. The Commissioner's view is that the application of these principles will require, in each case, a consideration of the terms of the relevant instruments to determine if, and when, they give rise to an amount being incurred.

The Full Court also found that the word 'income' in paragraph 25-90(1)(a) of the ITAA97 is a reference to income at general law and the test is therefore conducted by reference to the character of the receipt in the hands of the recipient. However, the Commissioner considers that an amount also has to satisfy the definition of a 'dividend' under subsection 6(1) of the ITAA36 for it to satisfy all of the requirements of section 25-90 of the ITAA97. If an amount is not income at general law or not a 'dividend' as defined under subsection 6(1) of the ITAA36, it will not satisfy the requirements of section 25 90 of the ITAA97 and no deduction will be available for an outgoing incurred in deriving that amount.

ATO view of the Part IVA issues decided at first instance

It was open to her Honour, on the facts of this case, to find that the dominant purpose of both the deduction and Withholding Tax schemes entered into was not to obtain a tax benefit.

Her Honour's conclusion, that the exclusion in subparagraph 177C(2)(b)(i) of the ITAA36 was not engaged because the allowance of the deduction to Noza could not be said to be attributable to the making of the election to consolidate, was in accordance with the Commissioner's view.

Administrative Treatment

Implications for ATO Precedential documents (Public Rulings & Determinations etc)

On 20 February 2013, an addendum was issued for Taxation Determination TD 2009/21. That addendum amended footnote 3 in paragraph 6 of that Taxation Determination to include a reference to Commissioner of Taxation v Noza Holdings Pty Ltd [2012] FCAFC 43 at [42] and [44].

Implications for Law Administration Practice Statements

None

Legislative References:
Income Tax Assessment Act 1997 (Cth)
25-90

Income Tax Assessment Act 1936 (Cth)
23AJ
44(1)
128B
177C
177D
177F

Corporations Act 2001 (Cth)
254T
254V(2)
256D

Case References:
BHP Billiton Finance Ltd v Commissioner of Taxation
[2009] FCA 276
(2009) 72 ATR 746

Bluebottle UK Ltd v Deputy Commissioner of Taxation
[2007] HCA 54
(2007) 232 CLR 598
67 ATR 1
2007 ATC 5302

Commissioner of Taxation v American Express Wholesale Currency Service Pty Ltd
[2010] FCAFC 122
(2010) 187 FCR 398
2010 ATC 20-212
77 ATR 12

Commissioner of Taxation v Australian Guarantee Corporation Ltd
[1984] FCA 240
(1984) 2 FCR 483
15 ATR 982
84 ATC 4642

Commissioner of Taxation v Citylink Melbourne Limited
[2006] HCA 35
(2006) 228 CLR 1
62 ATR 648
2006 ATC 4404

Commissioner of Taxation v Day
[2008] HCA 53
(2008) 236 CLR 163
2008 ATC 20-064
70 ATR 14

Commissioner of Taxation v McNeil
[2007] HCA 5
(2007) 229 CLR 656
64 ATR 431
2007 ATC 4223

Emu Bay Railway Company Limited v Commissioner of Taxation
[1944] HCA 28
(1944) 71 CLR 596

Hooker Rex Pty Ltd v Commissioner of Taxation
(1988) 79 ALR 181
19 ATR 1241
88 ATC 4392

Marra Developments Ltd v B W Rofe Pty Ltd
[1977] 2 NSWLR 616
15 ATR 1
83 ATC 4709

Nilsen Development Laboratories v Commissioner of Taxation
[1981] HCA 6
(1981) 144 CLR 616
11 ATR 505
81 ATC 4031

Ronpibon Tin NL v Commissioner of Taxation
[1949] HCA 15
(1949) 78 CLR 47

Commissioner of Taxation v Consolidated Press Holdings Ltd (No 1)
(1999) 91 FCR 524
[1999] FCA 1199
99 ATC 4945
42 ATR 575

Other References:
Explanatory Memorandum, Company Law