Organización y Reglas de funcionamiento del Mercosur

One final word – the retrospective operation to 1 March 2012, of changes which have not been described with any precision, is inimical to the rule of law. Is guarding the revenue against the loss of a court case or cases more important than protecting the rule of law?

Bill Thompson Minter Ellison September 2012

APPENDIX A

Relevant applications of the Reasonable Expectation Test RCI Pty Ltd v Commissioner of Taxation⁵⁶

In RCI, the taxpayer was the immediate parent of companies within the US sub-group of the James Hardie Group of Companies. A wholly owned US subsidiary of the taxpayer re-valued its shares in another US company creating an asset re-valuation reserve of some US$318 million. The US subsidiary declared a dividend equal to the amount of the revaluation reserve to the taxpayer. The dividend was exempt from Australian tax under section 23AJ of the 1936 Act. The effect of the dividend was to reduce the value of the taxpayer's shares in the US subsidiary. Subsequently, the taxpayer sold its shares in the US sub-group holding entity for an amount which was correspondingly reduced. The extent of the reduction was equal to the amount of the dividend being US$318 million (or A$478 million).

– 2010

The transaction had occurred, broadly, in the context of a number of previous proposed transactions which had been considered by the group and as part of an overall commercial purpose of achieving a restructuring of the US group.

Stone J considered that the reasonable alternative postulate was that if the scheme constituted by the asset revaluation and dividend payment, had not been entered into, the shares sold by the taxpayer would have been sold in any event despite the large capital gain which would be realised. There was therefore a tax benefit in proceeding with the transaction in the way in which it had proceeded.

The Full Federal Court reversed the trial judge on this finding. The Commissioner was denied special leave to appeal to the High Court.

Commissioner of Taxation v AXA Asia Pacific Holdings Ltd⁵⁷

AXA Health Insurance Pty Ltd was a wholly owned subsidiary of AXA Asia Pacific Holdings Ltd (AXA) and operated a profitable health insurance business.

- 2010

From 2000 AXA was considering the future of AXA Health while in mid-2001 it had received an indicative proposal from MBF for the purchase of AXA Health. By late 2001 it was investigating either an initial public offering of AXA Health or a leveraged buy-out (LBO) proposal.

The LBO was proposed by Macquarie Bank Limited (MBL) and would involve AXA selling its shares in AXA Health into an unlisted leveraged company. The investors in that company would include MBL and other investors and debt funding of $300 million would be obtained. As the LBO proposal developed, MBL proposed that part of the transaction would include that the sale by AXA of its shares in AXA Health to the LBO acquisition company would be the issue of shares in the LBO acquisition company and, that to the extent that the consideration was comprised of shares, scrip for scrip rollover relief would be obtained under Sub-division 124M of the 1997 Act. The effect of obtaining scrip for scrip rollover relief is to defer the making of a capital gain on the disposal of the shares until a later CGT event occurs in respect of the replacement shares.

As a result of separate agreements entered into between AXA and the other

shareholders in the LBO acquisition company, AXA could call for the transfer to it of

56 (2010) 272 ALR 347.

57 (2010) 189 FCR 204.

the shares held by MBL and the other shareholder in the LBO acquisition company.

Conversely, AXA could require a company co-owned by MBL and the other shareholder to acquire AXA's shares in the LBO acquisition company.

Finally, the LBO acquisition company had entered into an arrangement with the company co-owned by MBL and the British insurer for the on-sale of AXA Health.

In the result, AXA did call for the transfer to it of the shares held by the other

shareholders in the LBO acquisition company; the LBO acquisition company did on-sell AXA Health to the company co-owned by MBL and the British insurer. The result was that AXA continued to hold the replacement shares in the LBO acquisition company when the only asset of the LBO acquisition company (it having on-sold the shares in AXA Health) was cash in the sum of $558 million.

In effect, AXA had sold AXA Health and indirectly held the proceeds of sale through its 100% ownership of the LBO acquisition company. By reason of the scrip for scrip rollover, only the $57 million received in cash was exposed to capital gains tax on the sale of AXA Health. Tax on most of the capital gain could be indefinitely deferred by AXA continuing to hold the cashbox company.

The Commissioner asserted that these arrangements constituted a Part IVA scheme.

The tax benefit was a capital gain in the amount of $383 million which would have been or might reasonably be expected to have been included in AXA's assessable income if the scheme had not been entered into or carried out. The Full Federal Court unanimously (on the Part IVA point) upheld the primary judge's conclusion that Part IVA did not apply. The reason was that the Full Federal Court agreed with the primary judge that AXA did not derive a tax benefit in connection with the presumptive scheme. The Commissioner contended that the alternative postulate was that AXA would have entered into a direct sale of AXA Health to the company co-owned by MBL and the British insurer which was the eventual buyer of AXA Health from the LBO acquisition company. Both the primary judge and the Full Federal Court rejected this as an alternative postulate which was reasonably possible. The uncontroverted evidence was that MBL would never have been part of a direct acquisition by that co-owned company of AXA Health, not least because it would not derive the significant anticipated fee income from that direct acquisition which it derived from the

transaction as undertaken.

The Full Federal Court noted, by way of obiter dicta that the other possibility which might reasonably have been expected was a direct sale of the business of AXA Health to MBF. However, that was not an alternative postulate to the sale of the shares in AXA Health by AXA as MBF was not interested in acquiring the shares in AXA Health but only its business. A sale of the business would have produced a capital gain for AXA Health, not for AXA.

The Commissioner filed an application for special leave to appeal to the High Court.

The High Court refused to grant special leave for the appeal.

Commissioner of Taxation v Lenzo⁵⁸

In Lenzo, the taxpayer had obtained various deductions through participation in a tree farming scheme. This included deductions for management fees and interest. In relation to Part IVA, the taxpayer had contended that the relevant 'counterfactual' if the investment in the tree scheme had not been paid was that a corresponding deduction would have been obtained by making contributions to superannuation.

Sackville J wrote the leading judgement, in which he:

58 (2008) 247 ALR 242.

a. concurred with the trial judge that the contribution to superannuation was not a 'relevant counterfactual' on the basis that the definition of 'tax benefit' required, in the case of an allowable deduction, that a deduction of the same kind would be obtained as the deduction obtained under the impugned scheme;

b. considered a further alternative postulate which had been accepted by the trial judge that the taxpayer instead of borrowing to make the investment in the tree scheme could have used his own funds (which were available) and obtained the same deductions. Sackville J considered that a difficulty with that alternative postulate was, because the definition of 'tax benefit' in section 177C(1) required that the alternative postulate be assessed on the basis that the scheme had not been entered into or carried out, that that meant that no part of the scheme could form part of the alternative postulate.

Special leave to appeal to the High Court was refused to the taxpayer.

Commissioner of Taxation v Trail Bros Steel & Plastics Pty Ltd⁵⁹

The decision in Trail Bros overtakes the decision of a differently constituted Full Federal Court in Lenzo. Although the Full Federal Court in Trail cited sections of Sackville J's reasons in support of the decision in Trail, it is apparent that the Full Federal Court's decision in Trail departs significantly from that of the Full Federal Court in Lenzo.

In response to changes in the superannuation law limiting the tax deductible

contribution which could be made in respect of employees to age based contribution limits in the 1997 year, the taxpayer company and certain of its employees orally agreed to vary their employment contracts so that instead of the taxpayer making superannuation contributions to the company's superannuation fund, the taxpayer would make payments to the Trail Bros Pty Ltd Employee Welfare Fund. Instead of the age based superannuation contributions of approximately $75,000 in aggregate which the taxpayer might have made to the superannuation fund, a contribution of $210,000 was made to the Welfare Fund.

The Administrative Appeals Tribunal (AAT) had found that the payments to the Welfare Fund were deductible under section 51(1) of the 1936 Act and under section 8-1(1) of the 1997 Act for the relevant years. While the AAT found that there was a relevant Part IVA scheme, it considered that there was no tax benefit as if the scheme had not been entered into, the taxpayer would have made payments 'in a way that would have entitled the taxpayer to deduct the amount of the payments'.

On appeal, the trial judge found that the taxpayer had obtained a tax benefit in each year and that the tax benefit was not the $210,000 paid to the Welfare Fund in each of the relevant years but the difference between the $210,000 and the superannuation contributions which might have been made. The Commissioner and the taxpayer appealed. The issues in dispute were whether the taxpayer obtained a tax benefit and if so the amount of the tax benefit. The significance of the Trail Bros case is its explanation of:

a. how the analysis of the counterfactual or alternative postulate at the core of the definition of 'tax benefit' is to be undertaken; and

59 (2010) 272 ALR 40.

b. how the amount of the tax benefit is to be calculated;

effectively changing the explanation of those issues by the differently constituted Full Federal Court in Lenzo's case.

The Full Federal Court unanimously agreed that the definition of tax benefit requires two things:

a. A determination of what would or might reasonably be expected to have happened if the scheme had not been entered into or carried out. The burden of proving this alternative postulate lies with the taxpayer, not the Commissioner. The

fundamental problem with the decision by the AAT in this case was that the AAT had no evidence in front of it from the taxpayer as to an alternative postulate.

b. That alternative postulate must be premised upon the assumption that 'the scheme had not been entered into or carried out'. They are the words of the definition in the statute. That requirement means that the assumption which must be made is that the entire scheme had not been entered into or carried out.

Significantly, however, the Full Federal Court in Trail Bros explained that that requirement does not preclude an activity or events which include some of the 'integers' of the impugned scheme from being the alternative postulate.

'A scheme is usually comprised of a number of 'steps' or 'integers'. It is conceivable that a scheme (comprising just some of the integers of a wider scheme to which Part IVA applies) may be a scheme to which Part IVA does not apply. If the narrower scheme is the particular activity or the events that would have or might reasonably be

expected to have taken place in the absence of the scheme, then that is the alternative postulate. The difference between the deduction claimed in relation to the scheme and the allowable deduction from the narrower scheme is the tax benefit. Similarly, the alternative postulate may

comprise some of the integers of the scheme to which Part IVA applies and other integers which do not form part of that wider scheme. … The

"integers" that are relevant to that objective enquiry are not limited and "may not always permit the precise identification of … all the integers of a particular 'scheme'": Hart 217 CLR 216 at (43). The integers will be different for each case and the onus is on the taxpayer to identify those integers which establish the alternative postulate.'⁶⁰

The alternative postulate requires a 'prediction as to events which would have taken place if the relevant scheme had not been entered into or carried out and that prediction must be sufficiently reliable for it to be regarded as reasonable'. 'A reasonable expectation requires more than a possibility'

(emphases added)

61

The taxpayer may satisfy the burden of proof upon it in relation to the alternative postulate as it sees fit. The taxpayer's evidence of what it would have done but for entering the scheme is relevant to the extent it reveals facts or matters that bear upon the objective determination of the alternative postulate.

62

60 Ibid 48.

61 Ibid 47 (Dowsett and Gordon JJ) citing Commissioner of Taxation v Lenzo (2008) 247 ALR 242, 122 (Sackville J).

62 Ibid 49.

If the relevant tax benefit is in relation to an allowable deduction, then the

alternative postulate need not engage a provision of the Act giving rise to the same kind of deduction as that engaged by the impugned scheme. The

reference in section 177C(1)(b) to 'that deduction' not being allowable or not

reasonably being expected to have been allowable if the scheme had not been entered into or carried out is not a reference to the same type or category of deduction but to the amount of the deduction.

If the alternative postulate gives rise to a deduction under whatever provision of the Act, then the tax benefit is the amount by which the deduction allowed to the taxpayer under the impugned scheme exceeds the deduction which would have been allowable under the alternative postulate. Such an understanding of the definition of 'tax benefit' in relation to allowable deductions is consistent with the explanation of the definition of 'tax benefit' in relation to the exclusion of amounts from assessable income which was given in Spotless. The Full Federal Court noted that 'any suggestion to the contrary in earlier authorities (eg Lenzo) may now be put to one side as

explained in Spotless.'⁶³

In Trail, the Full Federal Court agreed with the trial judge that the alternative postulate was that the employer taxpayer would have contributed to superannuation up to the relevant age based contribution limits rather than contributing to the Welfare Fund.

The tax benefit was not the total of the amount contributed to the Welfare Fund but the excess of the contributions to the Welfare Fund over the contributions which would have been made to the superannuation fund based on age based limits.

The matter was remitted to the AAT for re-analysis on the basis of these explanations of the concept of 'tax benefit' and for a consideration of the question of dominant purpose which the AAT had not considered given its finding that there was no tax benefit.

Commissioner of Taxation v BHP Billiton Finance Ltd⁶⁴

In broad terms, the Commissioner's Part IVA argument was that BHPB Finance obtained a bad debt deduction in respect of the inter-company loan to a BHPB subsidiary (TM) by writing off the debt owed by TM instead of forcing TM into

liquidation so that the liquidator would pursue a contractual claim against BHPB on the most recent letter of comfort provided by BHPB to TM. That course, it was argued, would have provided TM with the funds necessary to repay its loan and interest to Finance.

- 2010

The Commissioner made an important concession on appeal. He accepted that the debt owed by TM was bad. Accordingly, if it would be concluded that the debt was bad before BHPB revoked its comfort letter, then Finance would have derived no tax benefit by the asserted scheme of acquiescing in BHPB revoking the letter before Finance wrote off the debt. The debt would already have been bad and the deduction would have been available regardless of whether the letter of comfort was revoked or not.

The question which the Full Federal Court therefore considered was, was the TM loan a bad debt prior to the revocation by BHPB of the comfort letter.

The Full Federal Court considered that on the authorities⁶⁵

63 Ibid 53.

a debt is bad if it is

reasonably to be regarded as irrecoverable. It is not necessary in making that decision to establish that nothing can ever be recovered. It must simply be 'conjecturally' bad.

64 (2010) 182 FCR 526.

On the basis that the TM debt was bad irrespective of the withdrawal of the comfort letter, there was no tax benefit. Part IVA did not apply.

By way of obiter dicta, the Full Federal Court offered however that even if there was a tax benefit it was difficult to see how the conclusion of dominant purpose to obtain the asserted tax benefit could be reached having regard to the eight factors in

section 177D(b).

British American Tobacco Australia Services Limited v Commissioner of Taxation⁶⁶

In 1999, as part of a global merger of the British American Tobacco Group of Companies (BAT Group) and the Rothmans International Group of Companies

(Rothmans Group) the taxpayer (a member of the BAT Group formerly known as WD &

HO Wills Australia Limited) was required by the Australian Competition and Consumer Commission (the ACCC) to divest itself of nine tobacco brands which it owned at that time (the nine Wills brands).

- 2010

Following the merger of the BAT Group and the Rothmans Group, the taxpayer sold the nine Wills brands to Rothmans Pall Mall (Australia) Limited for a price of

approximately $182 million. The taxpayer claimed rollover relief for that transfer. The transferee, Rothmans, immediately on-sold the nine Wills brands for the same price to companies within the group of Imperial Group PLC (an unrelated company).

The Commissioner asserted that the transaction constituted a Part IVA scheme. The Rothmans Holdings Group had in excess of $163 million of capital losses which could be utilised to offset against capital gains arising in the Rothmans Holdings Group. The transfer of the nine Wills brands to the Rothmans Group had the effect of locating the capital gain on the on-sale to the Imperial Group within Rothmans where it was sheltered by the available capital losses.

The taxpayer submitted that the scheme was the choice which it made to obtain the

The taxpayer submitted that the scheme was the choice which it made to obtain the