• The impact of this case on ATO policy is discussed in Decision Impact Statement: Commissioner of Taxation v Tasman Group Services Pty Ltd (164 of 2008; 165 of 2008).

FC of T v TASMAN GROUP SERVICES PTY LTD

Judges:
Ryan J
Kenny J
Stone J

Court:
Full Federal Court, Melbourne

MEDIA NEUTRAL CITATION: [2009] FCAFC 148

Judgment date: 22 October 2009

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Ryan, Kenny and Stone JJ

Introduction

1. These taxation appeals and cross-appeals are from a judgment of a single judge of the Court in which his Honour allowed the respondent's appeals against the appellant's objection decisions:
Tasman Group Services Pty Ltd v Commissioner of Taxation of the Commonwealth of Australia 2008 ATC ¶20-002; [2008] FCA 23. The objection decisions related to the application of the "Forgiveness of commercial debts" provisions contained in Div 245 of Sch 2C of the Income Tax Assessment Act 1936 (Cth) (1936 Act). The "map" of Div 245 as set out in s 245-3 indicates that Div 245 is concerned to require the "total net forgiven amount" of all commercial debts forgiven in the same year of income to be applied to reduce certain revenue and capital losses, deductible amounts and the cost bases of certain assets attributable to the taxpayer whose debt has been forgiven. Div 245 provides a method for the valuation of the "total net forgiven amount" of the commercial debts to which it applies.

2. As the Commissioner put it, "[a]t stake in these proceedings are the respondent's revenue losses of $70,699,732, capital losses of $761,439, deductible expenditures of $27,340,510 and cost bases of $18,043,556". According to the Commissioner each of these amounts should be disallowed or reduced pursuant to Div 245. It should be noted that in these reasons we discuss the statutory provisions as they were at the relevant time. Since that time there have been some (generally minor) amendments to which it is not necessary to refer in these reasons.

3. The cross-appeal brought by the respondent to the Commissioner's appeal challenges the primary judge's conclusion that Div 245 applies in the circumstances under consideration. The appeal challenges the primary judge's conclusion as to the criteria to be applied in determining the "total net forgiven amount" of the debts to which the primary judge found Div 245 to apply.

Background

4. The respondent, Tasman Group Services Pty Ltd, was formerly known as SBA Foods Pty Ltd (SBAF). SBAF was a wholly-owned subsidiary of a Japanese corporation known as Sumikin Bussan Corporation Limited (SBC). In November 1996, SBC used SBAF as a vehicle to acquire the meat processing and export business formerly owned and operated by the Gilbertson Group. The acquisition was funded partly by share capital subscribed by SBC and partly by loans, also from SBC. Subsequently, SBC made a series of further loans to SBAF. Ultimately, on 27 February 2002, SBC sold the shares in the respondent (then SBAF) to a third party, Tasman Group Holdings Pty Ltd. As at 1 March 2002, the total amount outstanding on the loans was $118,696,459.

Findings of the primary judge

5. The learned primary judge found that SBAF had its main plant and head office at Altona in Victoria; other plants at Longford in Tasmania and on King Island; a wholesale depot at Gepps Cross in South Australia; and some retail outlets. His Honour also found, at [11]-[13], that:

"From the commencement of trading in November 1996, three SBC executives were

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assigned by SBC to assume active participation in the management of SBAF. They were appointed respectively as Deputy Managing Director, Marketing Director and Finance Manager. They and their subsequent replacements were paid directly by SBC. They occupied offices at SBAF's Altona head office. Under a formal agreement, which was varied from time to time, SBAF paid a fee to SBC for the services of these executives.

The chairmen of SBAF from time to time were senior members of SBC's board in Japan. They travelled to Australia for the monthly meeting of the SBAF board. Occasionally the SBAF board met in Japan and Australian resident directors would travel to meetings.

Decisions concerning matters such as capital expenditure, payroll, staffing levels, repairs and maintenance and export marketing were subject to SBC's approval, based on submissions and recommendations by the three SBC executives."

6. Further, the primary judge found that SBC initially made three loans (denominated in Japanese yen) for the purpose of the acquisition of the business. These loans, which can be called the Acquisition Loans, were made by SBC to SBAF in November 1996 and January 1997.

7. As it turned out, the meat processing and exporting business was not successful. The amounts in the table at [15] of the primary judgment indicate that, from July 1997 to December 2001, SBAF incurred trading losses amounting to $128,932,000. During this time SBAF was able to trade because SBC made a number of loans to provide working capital and permit capital investment. The same table shows that, in the period from June 1999 to February 2002, these loans, referred to hereafter as "the Subsequent Loans", totalled $92,842,707.

8. The primary judge noted that the loans from SBC to SBAF were evidenced by formal agreements all in the same form. Each agreement specified a rate of interest payable on an "Interest Repayment Date" and stipulated repayment of the loan in full in Australian dollars on a stated "Repayment Date". Each agreement recited that it should "be governed by and construed in accordance with the laws of Japan". Later variations of arrangements for repayment of principal and interest under the Subsequent Loans were described in [19]-[20] of his Honour's reasons. These included SBC agreeing to exempt SBAF from interest payable on previous loans, after which loans were interest free. SBC also formally extended the time for repayment of the loans so that "[e]ventually all 29 advances from SBC had the same repayment date of 31 March 2002". In discussing finance provided by the ANZ Bank his Honour said at [21]:

"The ANZ Bank had been the Gilbertson Group's bankers. After the acquisition various proposals were discussed between the bank and SBC. Eventually the bank modified its requirement for subordination of shareholder loans and accepted that SBC give legally enforceable undertakings that the loans not be withdrawn without ANZ's consent. In a letter dated 12 December 1996 the bank confirmed that in the event of such an undertaking it would treat the loans as shareholders funds for the purpose of measuring against proposed lending covenants. The undertaking was duly given."

9. In April 1999, at the insistence of its auditors, SBAF obtained a Letter of Comfort dated 25 May 1999 from SBC, in which SBC covenanted:

• 1. To not call for repayment of the loans outstanding at 31 December 1998 of ¥1,997,599,755 prior to 30 November 2001.
• 2. To continue to provide ongoing financial support to enable [SBAF] to meet its liabilities as and when they fall due.

10. Immediately before the end of the moratorium fixed by that letter, SBC provided a further Letter of Comfort dated 20 November 2001, which was in substantially the same terms as the earlier letter and recited:

"LETTER OF FINANCIAL SUPPORT

[SBC] is the parent entity of [SBAF]. The parent entity acknowledges that as at 31 October 2001 the current liabilities of [SBAF] exceed its current assets and if the parent entity called for repayment of its

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debts, [SBAF] would be unable to pay its debts as and when they fall due.

After due consideration of these facts the parent entity covenants

• 1. To not call for repayment of the loans outstanding at 31 October 2001 of A$67,600,000.00 and ¥3,167,690,801 prior to 30 September 2003.
• 2. To continue to provide ongoing financial support to enable [SBAF] to meet its liabilities as and when they fall due.

The above covenants, which are operative from the date of this letter shall remain in force and shall not be revoked until such time as the deficiency in working capital is corrected, the company is sold its [sic] entirety or [SBC] sells its shares.

Yours faithfully,

[SBC]"

11. According to the primary judge, Tasman Group Holdings "emerged" as a buyer in January 2002 and ANZ agreed to extend facilities until 15 February 2002. By a Share Sale Agreement dated 27 February 2002, SBC sold its shares in SBAF to Tasman Group Holdings for about $17 million. At the time of the Share Sale Agreement, SBAF had not repaid any loan made to it by SBC. Under the Share Sale Agreement, however, SBC agreed to "ensure" that, on the Completion Date (1 March 2002) "no amount of Financial Indebtedness exists." "Financial Indebtedness" was defined to mean "financial indebtedness owed to the Vendor Group [SBC and related entities] by [SBAF]". The sale was completed on or about the Completion Date.

12. Also on 27 February 2002, SBC advanced $5.3 million to SBAF, which SBAF used to repay the amounts owing to ANZ. After the sale of the shares had been completed, SBAF's balance sheet disclosed no indebtedness to SBC. The primary judge stated, at [28]:

"Mr Malcom Slinger, who was the Managing Director of SBAF, deposed that, other than what is contained in the share sale agreement, he was not aware of, and has not signed, any other documents, agreements or deeds under which SBC expressly released or waived the amounts owing by SBAF to SBC."

Findings of primary judge challenged on the cross-appeal

13. The learned primary judge stated that, as to the application of Div 245, the following three issues arise:

• 1. Did SBAF owe SBC any debt ?
• 2. Was any such debt a commercial debt ?
• 3. Was any such debt forgiven ?

14. The Commissioner did not dispute his Honour's resolution of these issues and made no submissions concerning them. The respondent, by its notices of cross-appeal, contended that his Honour was in error in holding that some or all of the relevant loans advanced by SBC to SBAF were "debts" within the meaning of s 245-15(1), or "commercial debts" within s 245-25 of the 1936 Act. The respondent contended further, or in the alternative, that his Honour had erred in holding that each of the relevant loans from SBC to SBAF had been forgiven as contemplated by s 245-35(1) of the 1936 Act.

15. For the purposes of the cross-appeal it is therefore necessary to examine the reasoning that underlies his Honour's resolution of the issues concerning the existence and nature of the debts identified in [12] above and whether they were forgiven. As the determination of those debt issues logically precedes the determination of the issues raised in the Commissioner's notice of appeal, we will deal with the three debt issues first. The final issue in the cross-appeal concerns the application of s 245-55 of Subdiv 245-C, including the "notional value" of each of the SBC loans. The resolution of this issue depends in part on whether the presumption of insolvency applies, which is the central issue in the Commissioner's appeal. These issues are discussed together below.

Did SBAF owe a debt to SBC?

16. In the light of the facts recounted above, the primary judge held that the unpaid loans advanced by SBC to SBAF constituted a "debt" as defined in s 245-15(1) of the 1936 Act, each loan being "an enforceable obligation imposed by law on a person to pay an amount to another person." In so concluding, his

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Honour rejected an argument advanced by the respondent that the loans were, on 1 March 2002, unenforceable because SBC would have breached its covenants both to SBAF and ANZ had it sought repayment, and would have been estopped from enforcing the loan agreements according to their terms. His Honour explained his rejection of this contention in his reasons at [31]-[35]:

"The short answer is that there is still an enforceable obligation imposed by law to pay a creditor even if the time for payment is postponed or deferred. In terms of the legislative purpose of Div 245, there is just as much an economic benefit for a debtor if his creditor forgives a debt which is not yet due for payment as there is when the debt is due, or overdue.

With the SBC loans there was not a condition precedent to the coming into existence of the liability, as was the case in
Emu Bay Railway Co Ltd v Federal Commissioner of Taxation (1944) 71 CLR 596. The loan agreements, under which money was advanced, stipulated dates for repayment and created unconditional obligations, notwithstanding that such obligations were extended from time to time: cf
Federal Commissioner of Taxation v Citylink Melbourne Limited (2006) 228 CLR 1 at [134]. Prior to the sale of share agreement, there was no suggestion that SBC's rights would be abandoned.

Some points can be made as to the construction of the letters of comfort, or more specifically, the second one, which was operative at the relevant time.

First, covenant 2 relating to "ongoing financial support" is an obligation distinct from and independent of covenant 1. Consistently with the letter SBC could call for repayment after 30 September 2003 but still be obliged to "continue to provide ongoing financial support".

Secondly, both covenants were no longer operative once SBC sold its shares in SBAF. This is inconsistent with the necessary implication in the applicant's argument that on selling its shares SBC was still inhibited from enforcing its right of recovery against SBAF."

17. The respondent contended that, for a debt to exist for the purposes of s 245-35 of the 1936 Act, there must, immediately before the putative forgiveness, be an enforceable obligation to repay it. According to the respondent, SBAF was under no such enforceable obligation because the Letters of Comfort when read together meant that it was not, at the time of the sale of the shares, required to repay the loans to SBC. Indeed, it would have been a breach of the respective covenants in the Letters of Comfort for SBC to have called for repayment given its acknowledgement that SBAF would be insolvent if required to make repayment. It would also have been a breach of SBC's covenant with ANZ if it had called for repayment from SBAF without ANZ's consent.

18. Counsel for the respondent further contended that the learned primary judge had also fallen into error in that his Honour characterised the express terms of the loan agreement as creating debt rather than equity without going beyond those terms. Instead, it was argued, his Honour should have asked whether, at the time of the presumptive forgiveness, SBAF was under an enforceable obligation to repay the loans. That required him to take into account the substance, rather than the form, of the loan transactions and the fact that SBC and SBAF were parent and subsidiary and not dealing with each other at arm's length. The evidence supported a conclusion that SBAF was not obliged to repay the Acquisition Loans until it was in a financial position to do so. The evidence also supported a finding as to each of the Subsequent Loans that, both at the time when they were advanced and at all times thereafter, SBAF had no capacity to repay them.

19. As the primary judge noted, s 245-15(1) defines a debt as "an enforceable obligation imposed by law on a person to pay an amount to another person". The respondent's submissions relied heavily on chronology. It submitted that, because the covenants in the Letter of Comfort dated 20 November 2001 were expressed to remain operative until, amongst other events, SBC had sold its shares

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in SBAF, there could not have been an enforceable obligation pursuant to which SBAF was required to repay advances made by SBC. This submission failed to distinguish between the fact of an obligation to repay and the time for performance of that obligation. Although the time for payment of all advances had been extended to 31 March 2002, the obligation to pay on that date was overtaken by the Share Sale Agreement and SBC's undertaking to ensure that on completion there would be no financial indebtedness on the part of SBAF to SBC and its related companies. Completion of the sale on or about 1 March 2002 had the effect of forgiving SBAF's debts with the result that the time for performance of the obligation did not eventuate. This did not, however, alter the fact that, until completion, SBAF had an enforceable obligation imposed by law to pay the amount of the debts to SBC.

20. The respondent submitted that the primary judge "failed to construe the statutory definition in a purposive manner given that the Division is concerned with the "economic benefit" to the taxpayer of being relieved from the "economic burden" of a debt". In making this submission, the respondent focused on the fact that, as a practical matter, SBC had no expectation of ever being paid. Even accepting, for present purposes, the respondent's assessment of SBC's expectations, there is, nonetheless, a significant difference between expectations and legal rights. The fact that, realistically, SBC might not have expected to be repaid is not inconsistent with it intending to impose a legal obligation of repayment on SBAF. Similarly, the fact that SBC could have supported SBAF by way of further share capital is not to the point. It was entitled to choose to provide that support by way of debt and there was no suggestion that any loan transaction was a sham.

21. In our view, the present situation is distinguishable from that considered by the High Court in
Emu Bay Railway Company Limited v Federal Commissioner of Taxation (1944) 71 CLR 596. In that case a company issued debenture stocks and acknowledged that it was indebted to the debenture stock holders in specified amounts. Interest on those amounts was "to be a charge upon and payable only out of the net annual income" of the company. The company claimed that interest was incurred in the course of gaining assessable income and for this reason it should be deductible. In the relevant period however, there had been no net income of the company and for this reason the majority of the High Court (Latham CJ, Starke and McTiernan JJ, Rich and Williams JJ dissenting) held that the interest was not deductible. As Latham CJ explained at 606:

"As there has never been any such net income, the interest which the company claims is allowable as a deduction did not become payable, has not become a debt and may never become a debt. … Not only has no outgoing been made, but no liability to make an outgoing has come into existence."

22. In similar vein, Starke J referred at 611 to the Commissioner's contention that the taxpayer incurred no liability for interest and came under no obligation in the relevant year to pay interest, and said:

"The Commissioner is, I think, right in this contention. The terms and conditions of the stock certificates explicitly provide that the interest is to be payable only out of the net income of the taxpayer of each year as defined or provided in the trust deed."

23. As the above comments make clear, in Emu Bay a condition precedent had to be satisfied before the obligation to pay interest arose. That is very different from the situation here where, in our view, the Letter of Comfort merely postponed the date for repayment of an existing unconditional debt. That being so the primary judge was correct to find that SBAF owed debts to SBC.

Were the debts owed by SBAF to SBC "commercial debts"?

24. As to whether each of the debts was a "commercial debt", the primary judge noted the definition of the expression "commercial debt" in s 245-25 of the 1936 Act, which provides:

• "(1) A debt is a commercial debt if subsection (2), (3) or (4) provides that the debt is a commercial debt.
• (2) Subject to subsection (4A), a debt is a commercial debt if the whole or any part of interest, or of an amount in the nature of interest, paid or payable in respect of the debt:
  • (a) is or would be allowable as a deduction to the debtor; or
  • (b) would be so allowable apart from the operation of an exception provision.

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  ATC 10221

  (3) A debt is a commercial debt if interest, or an amount in the nature of interest, is not payable in respect of the debt but, had interest or such an amount been payable, the whole or any part of the interest or amount:
  • (a) would have been allowable as a deduction to the debtor; or
  • (b) would have been so allowable apart from the operation of an exception provision."

25. At first instance, the respondent argued that, although the Acquisition Loans had been used to fund the acquisition of the business, with the result that interest on them might have been deductible in the initial years, it had later become clear that neither SBAF nor SBC intended that the Acquisition Loans should be repaid. At this point, the Acquisition Loans became analogous to an equity investment. Similarly, the Subsequent Loans were made to enable SBAF to repay other debts and to meet immediate requirements in order to stay in business. SBAF, as a stand alone entity, would have been insolvent and, accordingly, the Subsequent Loans were for the purpose of "propping up" its ailing business.

26. The primary judge rejected each of these contentions, observing at [40] of his reasons:

"In my opinion, both the Initial Loans and the Subsequent Loans constituted debt. They did not constitute equity, whether de facto or de iure. When anyone is planning to engage in business through the medium of a company the investment can be made via loans or share capital or a combination of both. On a risk and reward analysis, either course has its pros and cons. In the present case there was a decision by sophisticated business people to invest via loans. The loan agreements, the variations thereof and the payments made thereunder were properly documented. The documentation and the underlying commercial reality were consistent with each other. SBAF functioned as a separate entity, with regular formal meetings of its own board and independently audited accounts. There is no suggestion of sham. The fact that lender and borrower were parent and wholly owned subsidiary does not alter that characterisation."

27. The primary judge considered that the respondent was not assisted by Gyles J's insistence in
Spassked Pty Ltd v Commissioner of Taxation 2003 ATC 5099; (2003) 136 FCR 441 at [128] that the "requisite connection or relationship between the outgoing [being the interest payment] and the earning of assessable income [was] not to be inferred but must be positively established", where loans between a parent and subsidiary companies were "purely intra-group arrangements with no external aspect" and many of the companies involved had "no external role at all". In the present case, so the primary judge observed (at [41]):

"SBAF certainly had an external role. It was a trading entity in its own right, albeit an unsuccessful one, and used the borrowed funds for working capital to pay the expenses of its business."

Accordingly, his Honour found that the debts owed by SBAF to SBC were "commercial debts."

28. Counsel for the respondent contended that the learned primary judge should have considered, first, whether interest payable on the Acquisition Loans was an outgoing of capital or of a capital nature for the purpose of s 8-1(2)(a) of the Income Tax Assessment Act 1997 (Cth) (1997 Act). That was a question to be answered from a practical and business point of view having regard to the character of the Acquisition Loans as more akin to an equity investment. Particularly from 2002, after interest ceased to be paid on them, the obligation to pay interest should have been regarded as securing an enduring advantage and the interest therefore constituted outgoings of capital or of a capital nature. The characterisation of the Subsequent Loans did not turn solely on the use to which the borrowed funds were to be put. All of the relevant circumstances had to be weighed, including objects or advantages which the taxpayer sought in incurring the outgoing. The Subsequent Loans lacked the necessary

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connection to the derivation of assessable income because, at the time when the obligation to pay interest on them accrued, there was no prospect of SBAF making a net profit; the interest payable was out of proportion to any income that might have been derived.

29. Similarly, it was pointed out on behalf of the respondent that "the outgoings", presumably in the form of principal and interest under the loan agreements, were not contemporaneous with the gaining or producing of assessable income. Because they had been made to enable SBAF to repay other debts and remain in business although insolvent, they were too remote from the derivation of income and so should be characterised as having been outgoings of capital or of a capital nature. The relevant loan agreements had been made to keep SBAF afloat long enough to be sold off as a going concern. Similar considerations, the respondent submitted, applied to the interest payable on the Subsequent Loans. That interest was incurred "to preserve [SBAF's] existence as a loss-making entity with a view to selling it so as to minimize SBC's loss on its investment." The character of that advantage was said to be of a capital nature. In any event, the deductibility of interest on each Subsequent Loan had to be considered separately as the interest on at least some of those loans was manifestly of a capital nature.

30. Moreover, the respondent submitted, on this view SBAF's purpose in incurring the liability could not be assessed in isolation from SBC's purpose in advancing the Subsequent Loans. It was relevant to take account of the fact that SBC and SBAF were parent and subsidiary and not operating at arm's length and for this reason, according to the respondent, the primary judge should not have distinguished
Spassked v Federal Commissioner of Taxation (supra) on the basis described at [27] above.

31. As far as Spassked is concerned, the diagrams attached at 480-481 as annexures to the reasons of Hill and Lander JJ clearly bear out the assessment of Gyles J at 480 that "[m]any of the companies involved, including Spassked, had no external role at all". His Honour distinguished between "purely intra-group arrangements with no external aspect" and arrangements that embody business decisions that "with the benefit of hindsight … may be seen as negligent or even profligate". There can be little doubt that SBC's investment was, with hindsight, a bad decision. However it was quite different from the structure in Spassked. In that case Hill and Lander JJ, at 455 [44], quoted the conclusion of the primary judge concerning that structure and the loans entered into, "that there was no agreed plan, mechanism or time frame, according to which Spassked would cease to be a dividend trap, cease to be a repository of losses, and begin to receive dividends from GIH". Their Honours held at 475 [104] that the primary judge's conclusion was clearly justified and added:

"Repayment of the loans was not something to which Mr Daniels had given anything but a fleeting consideration. Rather it was hoped and expected that the Spassked structure would continue as long as it was useful. It indeed leads to the conclusion that the Spassked structure which depended upon Spassked not receiving assessable income while incurring interest which was capitalised was intended to continue into the indefinite future or, until it became necessary to terminate the structure."

32. The evidence accepted by the primary judge in this case was that in the first 12 months after SBAF acquired the business trading was satisfactory but it deteriorated from the latter part of 1997. His Honour noted at [16] that a basic contributing problem was the antiquated plant that made the company uncompetitive. This is a scenario quite different from that analysed in Spassked and, in our view, his Honour was correct to distinguish that case.

33. In concluding that SBAF's debts were commercial, his Honour observed that the Court is not concerned with SBC's purpose in making the loans but with SBAF's use of them. A similar issue arose in
GP International Pipecoaters Proprietary Limited v Federal Commissioner of Taxation 90 ATC 4413; (1990) 170 CLR 124 to which his Honour referred. That case concerned a company, the taxpayer, that was set up for the purpose of undertaking a pipe-coating contract with the State Energy Commission of Western Australia. The establishment costs, including the construction of the necessary plant, were met by

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two other companies which had successfully tendered for the work. The contract for the pipe-coating included an amount payable to the taxpayer company in respect of "establishment costs". The question arose as to whether the establishment costs should be characterised as receipts in the hands of the company. In a unanimous decision the High Court held that the receipts were assessable income. Their Honours stressed that the relevant question was not the nature of the expenditure made by the taxpayer in the construction of the plant and said, at 136-7:

"The relevant question is whether the receipt of the establishment costs was income in the taxpayer's hands. It is necessary to keep that question steadily in mind and not to confuse the character of the receipt with the nature of the asset acquired by application of the moneys received.

The appellant's argument was, in substance, that the plant was a capital asset, that the moneys expended in its construction were an expenditure of a capital nature by the taxpayer and that, as those moneys were received for the purpose of expenditure on the construction of the plant, their receipt was a receipt of capital. The first two steps may be accepted but the final step assumes that, when money is received for the purpose of its being expended by the recipient, the character of the receipt is necessarily determined by the character of its proposed expenditure by the recipient."

34. The respondents here have made a similar assumption in emphasising the purpose of SBC rather than SBAF. It is SBAF's purpose that is determinative. In our view the evidence here does not support the conclusion that SBAF's purpose in entering into the loans was other than for the purpose (not achieved as it turned out) of earning assessable income. We find no error in his Honour's conclusion that the debts were commercial debts.

Did SBC forgive the loans to SBAF?

35. The third question answered by the primary judge was whether there had been "forgiveness" of the relevant debts. The answer to that question was governed by ss 245-35(1) and (3) of the 1936 Act, which provide:

• "(1) A debt is forgiven if the debtor's obligation to pay the debt is released or waived, or is otherwise extinguished.
• …
• (3) If:
  • (a) the debtor and creditor in relation to a debt enter into an agreement or arrangement (whether or not enforceable by legal proceedings); and
  • (b) under the agreement or arrangement the debtor's obligation to pay the whole or a part of the debt is to cease at a particular future time; and
  • (c) the cessation of the obligation is to occur without the debtor incurring any financial or other obligation (other than an obligation that, having regard to the debtor's circumstances, is of a nominal or insignificant amount or kind);

  the debt or the part of the debt is taken to be forgiven when the agreement or arrangement is entered into. If, after the agreement or arrangement is entered into, the debt or the part of the debt is forgiven, the last-mentioned forgiveness is disregarded for the purposes of this Division."

36. The respondent argued at first instance that these provisions require that the debt be expressly forgiven and there was no evidence of any express forgiveness of any debt owed by SBAF to SBC. The primary judge rejected this contention noting, along the way, that the relevant provisions in the agreement for the sale of the shares in SBAF to Tasman Group Holdings, and the internal records of SBAF, were consistent with forgiveness. These records included minutes of a directors' meeting of 1 March 2002 recording "that SBC has agreed to cancel all the loans from SBC to (SBAF)" and a note to SBAF's financial records for the half-year ended 30 June 2002 recording the debt forgiveness. His Honour also summarised evidence of Japanese law, including Art 519 of the Japanese Civil Code, to the effect that "[if] the obligee declares to the obligor an intention to release the obligor from the obligation, such obligation shall be extinguished". The evidence of an expert in Japanese law was to the effect that the intention stipulated in Art 519 may be

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expressed orally, or in writing, or be implied by the obligee's conduct.

37. In his reasons at [51]-[52], the primary judge framed his conclusion on this point in these terms:

"In my opinion, the words of s 245-35(1) cannot be read down so as to require some express forgiveness. Waiver, for example, may be by conduct; it is an intentional act done with knowledge whereby a person abandons a right by acting in a manner inconsistent with that right:
Craine v Colonial Mutual Fire Insurance Co Ltd (1920) 28 CLR 305 at 326,
Grundt v Great Boulder Gold Mines Ltd (1937) 59 CLR 641 at 658. The expression 'or otherwise extinguished' is wide and would cover an agreement, enforceable in equity, not to set up the cause of action in debt:
McDermott v Black (1940) 63 CLR 161. SBAF was of course a party to the sale of shares agreement. After settlement of the sale of shares agreement and SBC's receipt of the purchase price from Tasman Group there is no way in which SBC could have recovered the debts previously owing by SBAF.

In any event, s 245-35(3) would apply, the 'particular future time' being the Completion Date (1 March 2002)."

Accordingly, his Honour held that the debts had been forgiven.

38. It was next contended on behalf of the respondent that Div 245 requires that the debt be expressly forgiven, as is made clear by s 245-265(1) of the Act, which stipulates that;

"A person (the debtor ) who incurs a commercial debt must keep any records that are necessary to enable the following matters to be readily found out:

• (a) the date on which the debt was incurred;
• (b) the identity of the creditor;
• (c) the amount of the debt;
• (d) the terms of repayment of the debt;
• (e) if the debt is not a moneylending debt and the debtor and the creditor were not dealing with each other at arm's length in respect of the incurring of the debt - the debtor's capacity at the time when the debt was incurred to pay the debt when it falls due;
• (f) if the debtor's obligation to pay the debt is forgiven - the date of the forgiveness and the consideration (if any) in respect of the forgiveness."

39. As we understand this argument, it rests on the proposition that record-keeping can only enable the date of the forgiveness to be readily found out if the forgiveness consists of an express act or, as with waiver, is constituted by an identifiable act or acts to which a date can be ascribed.

40. The respondent also contended that the execution of the Share Sale Agreement did not constitute or require forgiveness of the loans from SBC to SBAF. The respondent submitted that, in performing this agreement, "SBC could have made a gift to enable SBAF to repay the moneys, or could have procured a related company to subscribe share capital to enable repayment of the advances, neither of which would have given rise to a forgiveness of the liability." Nor, according to the respondent, had s 245-35(3) any application because there was no identifiable "particular future time" at which it had been agreed that SBAF's obligation to pay the whole or part of the debt should cease.

41. Finally, counsel for the respondent submitted in support of the cross-appeal that SBC would not have been treated as ranking pari passu with other creditors on a notional liquidation of SBAF. The Letters of Comfort would have been relied on by a notional liquidator to postpone the satisfaction of a proof of debt by SBC until third party creditors' claims had been met.

42. In our view, his Honour's conclusion about the forgiveness of the debt was correct. Both SBC and SBAF were parties to the Share Sale Agreement. Clause 8.2(a) of that agreement provided that SBC must ensure that on the completion date "no amount of Financial Indebtedness exists". "Financial Indebtedness" is defined in the agreement as financial indebtedness owing to the SBC Group by the Company. In our view, that clause coupled with the other records referred to by the primary judge (see [36] above) indicates a clear intention to waive SBAF's debts and that the

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waiver took effect. The evidence of the expert in Japanese law was that waiver by implication is possible under Japanese law. It is not to the point that the debt could have been extinguished in some other way when the evidence indicates waiver by implication from conduct.

43. Section 245-265 requires persons who incur commercial debts to keep certain records including, in subs (1)(f), "if the debtor's obligation to pay the debt is forgiven - the date of forgiveness and the consideration (if any) in respect of the forgiveness". There is no indication that a failure to keep such records, if failure there was, has any consequences for the validity of the forgiveness. Indeed, a note to the section suggests the contrary, in that it states that there is an administrative penalty if a debtor fails to keep the required records.

44. We agree with the primary judge that there is no basis for reading down s 245-35(1) to apply only to express forgiveness. Under Australian law (as well as Japanese law) there can be effective waiver by conduct. This was recognised as early as 1920 by the High Court in
Craine v The Colonial Mutual Fire Insurance Company Limited (1920) 28 CLR 305 where, at 326, the Court distinguished waiver by conduct from estoppel by conduct. The court said that waiver requires an intentional act with knowledge and that the requirement of intention must be,

"[S]uch as either expressly or by imputation of law indicates intention to treat the matter as if the condition did not exist or as if the forfeiture or breach of condition had not occurred."

See also
Grundt v The Great Boulder Proprietary Gold Mines Limited (1937) 59 CLR 641 at 658. In
The Commonwealth of Australia v Verwayen (1990) 170 CLR 394 at 407 Mason CJ discussed the nature of waiver and election and the necessity for the party said to have waived a right actually to have made an election as between two inconsistent rights. Whether what has occurred here is waiver in the strict sense identified by Mason CJ or in the more flexible sense of including estoppel as used in Verwayen by Dawson J at 457-9, we accept that either way the debt was extinguished. In any event, given the extensive authority supporting the extinguishment of a debt by implication from conduct we are of the opinion that if the Parliament had intended that forgiveness of a debt required express waiver it would have stipulated to that effect in clear terms.

Subdivision 245-C of Schedule 2C of the 1936 Act

45. The primary judge's affirmative answers to the three issues discussed above required him to consider the basis on which the notional value of the commercial debts that he found had been owed by SBAF and had been forgiven by SBC, should be calculated. As we have upheld his Honour's decision on those points, it is also necessary to consider this issue in the appeal.

46. Before embarking on that consideration it is necessary to give some attention to the purpose of Div 245 and the mischief it is designed to address. The second reading speech to the Taxation Laws Amendment Bill (No 2) 1996 (Cth) which introduced Div 245 made clear that the amendment was intended to ensure that the law properly taxed the economic benefit to a taxpayer of being forgiven a debt. As explained in the second reading speech, the amendment addressed what was seen as a "structural weakness" which was that,

"Notwithstanding that the act of forgiveness relieves the debtor of the economic loss represented by the debt, tax losses that accumulated before the debt was terminated generally remain available to shield future income from taxation."

47. Division 245 addresses the structural weakness by reducing accumulated losses and other deductions with reference to the value of the debt forgiven. Subdivision 245-C of Sch 2C of the 1936 Act sets out the steps to be followed in calculating the gross forgiven amount of a debt. Central to this calculation is s 245-55 which provides the test for working out the notional value of a debt (other than a non-recourse debt) at the time when it was forgiven. The notional value of a forgiven debt is the lesser of the amounts calculated in accordance with subss (2) and (3).

48. In each of subss (2)(a) and (3)(a)(i) the calculation is based on, amongst other things, the assumption that "the debtor was able to pay all the debtor's debts (including the debt concerned) as and when they fell due". This

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"assumption of solvency" is not included in the calculation if the exception provided in s 245-55(4) applies. Section 245-55(4) provides

• "(4) Paragraph (2)(a) and subparagraph (3)(a)(i) do not apply in relation to a debt if:
  • (a) either:
    • (i) at the time when the debt was forgiven the creditor was a resident; or
    • (ii) the forgiveness of the debt was a CGT event involving a CGT asset having the necessary connection with Australia; and
  • (b) the debtor and the creditor were not dealing with each other at arm's length in respect of the incurring of the debt; and
  • (c) the debt was not a moneylending debt."

49. Some elements of subs (4) are not in dispute since clearly: the creditor, SBC, was never an Australian resident; the debtor and creditor were not dealing with each other at arm's length in respect of the incurring of the debt; and, the debt was not a moneylending debt. Consequently, both before the primary judge and on this appeal, the only issue in relation to subs (4) is whether subpara 245-55(4)(a)(ii) applies. This depends on whether, in the relevant circumstances, the forgiveness of debt was: (a) a CGT event; (b) involving a CGT asset; (c) having the necessary connection with Australia.

50. The primary judge accepted that each debt was a "CGT asset" within the meaning of s 108-5(1) of the 1997 Act, which includes "any kind of property" in the category of CGT assets. Applying s 104-25 of the 1997 Act, his Honour was also satisfied that there had been a CGT event. His Honour accepted that the forgiveness of the debt due from SBAF to SBC fell within one or all of the descriptions found in the summary of CGT events in s 104-25 under the heading of "Cancellation, surrender and similar endings: CGT event C2". Such an event occurs -

"if your ownership of an intangible CGT asset ends by the asset:

• (a) being redeemed or cancelled; or
• (b) being released, discharged or satisfied; or
• …
• (d) being abandoned, surrendered or forfeited"

51. In view of these holdings there remained only one question for the primary judge to answer in determining whether the exception in s 245-55(4)(a)(ii) applied to exclude the assumption of solvency in subss 245-55(2)(a) and (3)(a)(i). The question was whether the relevant CGT asset had "the necessary connection with Australia". His Honour decided that there was the necessary connection and for that reason the assumption of solvency should be excluded.

52. Although the notice of appeal lists six grounds, ultimately they all come down to the one question, which is whether his Honour erred in excluding the assumption of solvency pursuant to s 245-55(4). In relation to that question, the only issue is whether SBC has "the necessary connection with Australia" required by subs (4)(a)(ii), there being no challenge to his Honour's findings in relation to the other elements of subs (4).

The necessary connection with Australia

53. There are several elements involved in a CGT asset having "the necessary connection with Australia", all of which must be satisfied if the necessary connection is to be established. The starting point is s 136-25 of the 1997 Act which stipulates that there are nine categories of CGT assets having the necessary connection with Australia. Relevantly they include, as category two:

"A CGT asset that you have used at any time in carrying on a business through a permanent establishment in Australia."

54. Section 995-1 of the 1997 Act defines "Business" as including "any profession, trade, employment, vocation or calling, but does not include occupation as an employee." "Permanent establishment" is also defined in s 995-1 as having the meaning given by s 6(1) of the 1936 Act, which is as follows:

• " permanent establishment , in relation to a person (including the Commonwealth, a State or an authority of the Commonwealth or a State), means a place at or through which the person carries on any business and, without limiting the generality of the foregoing, includes:
  • (a) a place where the person is carrying on business through an agent;
  • (b) a place where the person has, is using or is installing substantial equipment or substantial machinery;
  • (c) a place where the person is engaged in a construction project; and
  • (d) where the person is engaged in selling goods manufactured, assembled, processed, packed or distributed by another person for, or at or to the order of, the first-mentioned person and either of those persons participates in the management, control or capital of the other person or another person participates in the management, control or capital of both of those persons-the place where the goods are manufactured, assembled, processed, packed or distributed;

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  but does not include:
  • (e) a place where the person is engaged in business dealings through a bona fide commission agent or broker who, in relation to those dealings, acts in the ordinary course of his business as a commission agent or broker and does not receive remuneration otherwise than at a rate customary in relation to dealings of that kind, not being a place where the person otherwise carries on business;
  • (f) a place where the person is carrying on business through an agent:
    • (i) who does not have, or does not habitually exercise, a general authority to negotiate and conclude contracts on behalf of the person; or
    • (ii) whose authority extends to filling orders on behalf of the person from a stock of goods or merchandise situated in the country where the place is located, but who does not regularly exercise that authority;

      not being a place where the person otherwise carries on business; or

  • (g) a place of business maintained by the person solely for the purpose of purchasing goods or merchandise."

55. The primary judge identified SBAF's head office and plant at Altona in Victoria (as well as the plants at Longford in Tasmania and on King Island, the wholesale depot at Gepps Cross in South Australia, and some retail outlets) as the place(s) referred to in the opening lines of the definition. Crucial to his Honour's conclusion was his finding that the business carried on at the Altona plant and other locations mentioned was carried on by SBC, albeit that SBC operated the business "through its wholly owned subsidiary SBAF". His Honour did not elaborate on his reasons for that finding other than to say that "[t]he financing of that business was to a large extent through the loans which created the debts". His Honour therefore concluded that there was no assumption of solvency because the forgiveness of the debts was a CGT event involving a CGT asset having a necessary connection with Australia.

56. While it may be accepted that the business was being financed by SBC, this does not inevitably lead to the conclusion that SBC was carrying on the business. It is a trite proposition that, where a subsidiary, even if wholly owned by a parent company, carries on a business, the business is that of the subsidiary not the parent. Irrespective of how closely it may monitor the business activities of the subsidiary, the parent does not itself carry on those activities but is engaged in the separate business of a parent or holding company which is, normally, the receipt of income in the form of dividends from the subsidiary.

57. Counsel for the respondent in their written submissions on the appeal contended that it was at SBAF's head office at Altona that SBC, through its employees, managed and otherwise supported SBAF's operations and negotiated the terms of financing SBAF with its parent and its bank (original emphasis). In our view, the notion of SBC employees negotiating with SBC about the financing of SBAF's operations highlights the artificiality of an analysis erected on SBC's having conducted, "through" SBAF, the meat-processing business. To the extent that the relevant employees continued to be employed by, and answerable to, SBC, they had been seconded to SBAF to assist in the conduct of the business, a not uncommon arrangement when banks or

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other lenders insist on their own employees participating in the conduct of the business of customers who are being allowed to trade out of financial difficulties.

58. We are confirmed in our view that it was SBAF, and not SBC, that carried on the meat processing and exporting business by points made in oral submissions for the Commissioner. Senior counsel for the Commissioner, Mr Bloom QC, submitted that there were two businesses being carried on at Altona and the other locations: one was the business of SBC in providing employees for its subsidiary, SBAF; the other was the meat processing and exporting business being carried on by SBAF. In support of the submission that, at its highest, SBC's business in Australia was the supply of executives and that it was SBAF, and not SBC, that was carrying on the meat processing business, the Commissioner referred to the actual nature of the arrangements between the parent and its subsidiary and the way in which, as a practical matter, they managed both their business relationship and their tax affairs.

59. In particular the Commissioner relied on the arrangements as described by the primary judge in the passage quoted at [5] above. The Commissioner also emphasised that interest on the Acquisition Loans and the Subsequent Loans was at first paid by SBAF to SBC in Japan and was claimed by SBAF as a tax deduction and interest withholding tax deducted from the interest and paid to the Commissioner.

60. The concept of a "permanent establishment", according to the Commissioner, is used by all OECD members, including Australia, to measure whether a non-resident has a sufficient presence within a country to warrant taxation in that country of attributable business profits. In written submissions, the Commissioner stated:

"As the concept suggests, there must be a place - relevantly here in Australia - through which the non-resident carries on business, and it must have an element of permanence, both geographic and temporal. This is reflected in the definition of 'permanent establishment' in section 6(1) of the 1936 Act, and in the definition in each of the Double Tax Agreements to which Australia is a party; see for example, Article 3 of the Double Tax Agreement between Japan and Australia in schedule 6 to the International Tax Agreements Act 1953."

61. The Commissioner pointed out that various tax consequences ordinarily attached to a finding that a Japanese company carried on business through a permanent establishment in Australia, including that Australia became entitled to tax the Japanese resident on all the "industrial or commercial profits" attributable to that permanent establishment: see the Double Tax Agreement between Japan and Australia, art 4. According to the Commissioner, other Double Tax Agreements to which Australia is a party contain a similar provision. The Commissioner added that capital gains and losses that arise from disposal of an asset used by a company such as SBC in carrying on business through a permanent establishment would be assessable or deductible, as the case may be, in Australia. Furthermore, the Commissioner stated:

"[I]f a debt owed by an Australian subsidiary to its foreign parent is an asset used by the parent in carrying on a business through a permanent establishment in Australia, interest derived by the non-resident parent in respect of that debt will also be taxable in Australia and on an assessment rather than a withholding basis. It will be an 'industrial and commercial profit' within article 4 of the Japanese Treaty, being interest that is 'effectively connected' with the trade or business carried on through a permanent establishment in Australia (see article 4(5)(a))."

62. The Commissioner observed that: SBC's arrangement of its taxation affairs had not been consistent with its having carried on business through a permanent establishment in Australia; SBC had not returned, as assessable income in Australia, interest on the Acquisition Loans or Subsequent Loans paid to it by the respondent (although SBAF had claimed deductions in respect of that interest and withheld amounts on account of interest withholding tax); and it had not claimed in Australia capital gains or losses arising from the disposal of any assets used in carrying on business through any of the

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permanent establishments identified by the primary judge.

63. The money advanced by SBC was used in the meat processing and exporting business. Both the practical business arrangements and SBC's arrangement of its tax affairs described above have led us to conclude that that business was carried on by SBAF not SBC. The respondent also submitted that SBC carried on business through a permanent establishment in Australia as a holding company managing and financing its subsidiary in Australia. Whether there is any real difference between this business and that described by the respondent as being SBC's business in Australia is not clear, but on either description of the business we do not accept that it was carried on through a permanent establishment in Australia.

64. In any event, it is not to the point that the moneys advanced by SBC to SBAF were used by SBAF in its meat processing and export business. We are concerned with the debts arising from the making of advances to SBAF. Those debts were assets of SBC and the proper question is: how did SBC use the debts?

Did SBC use the loans to SBAF in carrying on business through a permanent establishment in Australia?

65. In case we are wrong in concluding that SBC did not carry on business through a permanent establishment in Australia, we have considered SBC's use of the debts created by the loans to SBAF.

66. As previously noted, the trial judge found that each of the SBC debts (the relevant CGT assets) was used by SBC in carrying on a business through a permanent establishment. The respondent submitted that his Honour's conclusion was a finding of fact. We do not accept this characterisation. His Honour reached his conclusion after applying s 136-25 to the facts in evidence before him. In our view, the question his Honour answered was a question of law which, it is true, depended on some findings of fact about the nature of the commercial relationship between SBC and SBAF. As such his Honour's conclusion was on a question of law;
Hope v The Council of the City of Bathurst (1980) 144 CLR 1 at 7 per Mason J, with whom Gibbs, Stephen, Murphy and Aicken JJ agreed.

67. The respondent submitted that, "[i]n view of the dire financial difficulties facing SBAF, SBC's business involved propping up and keeping the ailing subsidiary afloat by use of the SBC loans" and that, without the loans, SBC would have lost the benefit of its investment in SBAF. According to the respondent:

"[E]ach of the loans [was] subordinated, then successively extended and made no longer subject to interest, in order to ensure the continued support of ANZ and to enable SBAF to continue to meet its obligations as and when they fell due, in order to protect SBC's investment. That the loans were used by SBC in carrying on its business can be seen both in the provision of the loans and the manner in which their terms were subsequently modified. Not only were the SBC loans used to directly finance and keep SBAF afloat, they were also used, for example by leaving them in place, to ensure the ANZ's continued support.

The fact that the ultimate decisions to lend were formally made or ratified by SBC in Japan is irrelevant to where the loans were used - they were clearly used in Australia because that is where SBC's activities as a holding company managing the affairs of its subsidiary were conducted and it is where the funds were needed."

68. As we have already noted, it does not follow from the fact that the funds advanced were used in Australia that the debts created by the advances were used in Australia. Much less does it follow that they were used in a business carried on through a permanent establishment in Australia. We find compelling the

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Commissioner's submission that these assets were "used" by SBC as it used assets deployed in the businesses of SBC's many subsidiaries and associated companies throughout the world and not " through " a permanent establishment in any particular country, unless it were Japan.

69. The respondent argued that s 245-55(4)(a)(ii) of the 1936 Act specifically contemplated that certain non-moneylending debts created in non-arm's length circumstances and forgiven by a non-resident would have been "used" by the non-resident in carrying on a business through a permanent establishment in Australia, with the result that they were subject to the capital gains provisions. The respondent submitted that a debt would have "the necessary connection with Australia" for the purposes of s 245-55(4)(a)(ii) (as it then stood) if (at any time) there had been a nexus between the use of the debt by the creditor and the carrying on of a business by the creditor through a permanent establishment. In this case, so the respondent said, "[t]he SBC loans pertained solely to SBC's investment in SBAF and were employed in the business carried on by SBC in Australia; a contrary finding would render s 245-55(4)(a)(ii) inoperative". The respondent argued that, even if the SBC loans had been used by SBC in carrying on business in Japan, this would not preclude the inapplicability of the solvency assumption in s 245-55(4)(a)(ii) since it was sufficient if the loans were used by SBC at any time in carrying on its business in Australia.

70. The policy underlying Div 245 of the Act and, in particular, the assumption of solvency as discernible from the second reading speech and the explanatory memorandum which accompanied the Taxation Laws Amendment Bill (No 2) 1996 (Cth) was said by counsel for the respondent to be "to avoid both the debtor and the creditor obtaining a tax deduction in respect of what is 'broadly the same loss'". That rationale may be accepted while denying its application to the circumstances of the present case. That is because the debts owed by SBAF, viewed as they must be for purposes of s 245-55(4) as assets of SBC, were not CGT assets "that you [SBC] have used at any time in carrying on a business through a permanent establishment in Australia." For the reasons explained above, the business carried on through the establishments at Altona and elsewhere in Australia was the business of SBAF, not its parent SBC. It follows that the presumptive CGT assets in the hands of SBC, being the debts owed by SBAF, were not used by SBC in the carrying on of the meat-processing business in Australia.

71. As the Commissioner's argument implied, the use by SBC of the assets constituted by the debts consisted of receiving interest payments or debiting SBAF in respect of its liability and extending from time to time the date for repayment of principal or interest. That was analogous to the use made by a banker of assets represented by loans to its customers and if there was a permanent establishment through which the business in which the use occurred was carried on, that establishment was in Japan.

72. Contrary to the contention of counsel for the respondent, this analysis does not ascribe an unduly narrow meaning to the word "used" in s 136-25 of the 1997 Act. That sub-section is capable of applying to a wide range of CGT assets but the range of uses to which an asset may be put varies according to the nature of the asset. Where a relevant asset consists of a debt, there is limited scope for "using" it in carrying on a business other than one of, or analogous to, moneylending.

73. Excluding the assumption of solvency meant that it was necessary for his Honour to calculate the value of the debt (considered as an asset of the creditor) at the time when it was forgiven as if the debtor's capacity to pay the debt at that time had been the same as the debtor's capacity to pay the debt when it was incurred. Because there was no assumption of solvency, and it was not suggested that there had been any relevant changes in market variables, there was no need to calculate the second applicable amount referred to in s 245-55(3).

74. As we have concluded, for reasons given above, that the solvency assumption is not excluded, it is not necessary to consider the respondent's submission as to how the value of the debts should be calculated in its absence.

75. For these reasons the appeals must be allowed. The cross-appeal in each matter should be dismissed. In each matter Orders 1 to 5 of the orders made by the primary judge on 3 March 2008 shall be set aside and in lieu thereof the objection decision in each matter is affirmed. The respondent must pay the appellant's costs of the appeal and the cross-appeal and the proceeding before the primary judge.