When the ATO attacks corporate transactions - some recent Part IVA cases

Articles Written by Jane Trethewey

Introduction

A number of Federal Court and the Full Federal Court (FFC) decisions were handed down in 2010 which deal with the application of the general anti avoidance provision in Part IVA of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936) to corporate transactions that had an overall commercial purpose. This article briefly discusses 4 of those cases.

Futuris Corporation Limited v Commissioner of Taxation [2010] FCA 935 ('Futuris')

This was a decision of Besanko J, handed down on 31 August 2010.

It concerned the application of Part IVA to increase by approximately $83M the amount of the assessable capital gain derived by the applicant (Futuris), a public listed company, on the disposal of its shares in a subsidiary, Walshville Pty Limited (Walshville) in the year ended 30 June 1998. That disposal occurred in connection with the public float the group's 'Building Products Division' in October 1997.

Besanko J allowed Futuris's appeal, holding that it had not obtained a 'tax benefit' for the purposes of Part IVA. The Commissioner has appealed to the FFC.

Facts

The assets which comprised the Futuris group's 'Building Products Division' were owned by 2 subsidiaries of Futuris, namely Vockbay Pty Limited (Vockbay), which owned the 'Bristile' entities or assets, and Walshville, which owned the 'Prestige' entities or assets. The evidence was that the enterprise value of the Building Products Division was $250M, of which the Bristile assets were worth $210M and the Prestige assets were worth $40M.

Seven (7) steps were carried out in September and October 1997. The first 5 steps (under which the Bristile entities and assets were transferred to Walshville) took place on 2 September 1997 and the last 2 steps (including the sale of Futuris's shares in Walshville ‑ by then called Bristile Limited ‑ under the float for the total sum of $150M) taking place on 9 October 1997.

Steps 2-4 (which included a dividend of from Vockbay to Futuris of $63M) had the effect of increasing the cost base of Futuris's cost base in its Vockbay shares by $63M.

Step 5 was the sale by Vockbay of all of its shares in the company then called Bristile Limited (Bristile) to Walshville at a discount of approximately $83M to the market value of those shares, which had the effect of increasing the value of Futuris's Walshville shares by $83M and reducing the value of its shares and loans in Vockbay by the same amount. The 'value shifting' provisions in former Division 19A of the ITAA 1936 applied to reduce the cost base of Futuris's shares in, and loans to, Vockbay by $83M and increase the cost base of its Walshville shares by the same amount. In short, it had the effect of transferring approximately $83M of cost base from Futuris's Vockbay shares and loans (which had been increased by the previous steps) to its Walshville shares.

The Commissioner contended that the 'scheme' for the purpose of Part IVA consisted of steps 2-4 (narrow scheme) or, in the alternative, steps 2-5 (wide scheme).

Scheme, tax benefit and 'counterfactual'

Besanko J held that it was not necessary for the 'scheme' to include the actual disposal of the Walshville shares (i.e. step 7), even though there would have been no capital gain (and therefore no tax benefit) without that step. Section 177D requires that a tax benefit is obtained 'in connection with the scheme', words which His Honour said were 'of wide import'.

His Honour also held that the Commissioner was not required to identify the 'counterfactual' or 'alternative postulate' that he contended would, or might reasonably be expected to, have happened if the scheme in question was not entered into or carried out, giving rise to the larger capital gain assessed by the Commissioner. It is the taxpayer, not the Commissioner, who bears the onus of proof. His Honour said this requires the taxpayer, not just to disprove the Commissioner's alternative postulate, but to positively establish what transactions or arrangements it contends would or might reasonably be expected to have been undertaken in the absence of the scheme.

However, Besanko J held that, on the evidence led on its behalf, Futuris haddischarged this onus.

Firstly, his Honour found, on the evidence, that there were 3 counterfactuals before him ‑ one involving the sale of the Prestige assets from Walshville to Bristile and then the float of Bristile (Futuris Counterfactual 1), another involving the transfer of Futuris's and Vockbay's shares in Bristile to Walshville and the float of Walshville and the other consisting of the transactions that actually did occur but without steps 2-5 referred to above.

His Honour found that Futuris had established that, had the scheme identified by the Commissioner not been carried out, it was reasonable to expect that Futuris Counterfactual 1 would have been carried out. This did not give rise to a tax benefit for Futuris, as no capital gain would have arisen for Futuris (rather, capital gains of $19.9M and $74M would have been realised by Walshville and Vockbay, respectively). Considerably higher capital gains would have arisen for the group under the other 2 counterfactuals (i.e. $142.3M to Vockbay and $10M to Futuris under Futuris Counterfactual 2 and $142.3M to Vockbay and $92.7M to Futuris under the Commissioner's Presumed Counterfactual).

His Honour's findings were largely based on the unchallenged evidence of Mr Duivenvoorde, a chartered accountant specialising in corporate finance, to the effect that there were good commercial reasons why Futuris Counterfactual 1 would occur, involving as it did the less valuable Prestige assets held by Walshville being transferred, rather than either of the other counterfactuals, which involved the transfer of the significantly more valuable Bristile assets.

Dominant purpose

While the finding that there was no tax benefit was sufficient to dispose of the appeal, Besanko J went on to consider whether it would be concluded, assuming that Futuris did obtain a tax benefit, that any person who entered into or carried out the scheme did so for the dominant purpose of enabling a tax benefit to be obtained.

In this regard, his Honour considered each of the 8 matters listed in s 177D(b), as well as a global assessment of those matters, and held that, if Futuris had obtained the tax benefit, he would have concluded that Futuris and its relevant subsidiaries entered into or carried out the scheme for the dominant purpose of enabling Futuris to obtain the tax benefit. In short, his Honour found that there was no commercial imperative for carrying out the particular transactions which had the result of increasing the cost base of the Walshville shares, thus reducing the capital gain on the disposal of those shares under the float, without any corresponding taxable amount arising (as the various dividends were effectively non-taxable due to the inter-corporate dividend rebate under former s 46).

This was notwithstanding that the overall purpose of the transactions as a whole was to realise a profit on the public float of the Building Products Division.

RCI Pty Limited v Commissioner of Taxation [2010] FCA 939 ('RCI')

This was a decision of Stone J, handed down on 3 September 2010. Stone J disallowed RCI's appeal against the Commissioner's assessments. RCI has appealed to the FFC.

Facts

The applicant (RCI) was a wholly owned subsidiary of James Hardie Industries Limited (JHIL), an Australian resident company that was, until October 2001, the ultimate parent of the James Hardie group. RCI owned all of the shares in JHH, a UScompany which was the holding company of the James Hardie group's USsubsidiaries. RCI's wholly owned US subsidiary, James Hardie Holdings Inc. (JHH(0)) held a minority interest in James Hardie USA Inc. (JHH(1)), which was a USsubsidiary of the group.

The case concerned the application of Part IVA to increase a capital gain derived by RCI on the disposal of its shares in JHH(0) to RCI Malta Holdings Limited (RCI Malta), another wholly owned subsidiary of RCI, in October 1998. This disposal was part of a re-organisation of the James Hardie group to establish a more commercially efficient structure.

The Commissioner increased RCI's capital gain by US$318M, being the amount of a dividend paid by JHH(0) to RCI prior to the disposal of the shares, reducing the value of the shares and therefore the capital gain on their disposal.

The steps giving rise to the dispute were as follows:

  1. In about March 1998, JHH(0) revalued its shares in JHH(1), resulting in the shares increasing in value by US$318M.
  2. The Board of JHH(0) resolved on 30 March 1998 to declare a dividend of $318M to RCI. This dividend was non-assessable non-exempt income of RCI under s 23AJ of the ITAA 1936.
  3. JHH(0) met its obligation to pay the dividend by a cash payment of US$20M to RCI and by issuing a promissory note (PN1) to JHIL, payable on 28 September 1998, in exchange for JHIL making a payment of US$298M to RCI.
  4. On 26 August 1998, RCI injected approximately US$50M additional equity into JHH(0) by subscribing for 570 additional shares in JHH(0). This was necessary to satisfy the USthin capitalisation rules, due to the decrease in JHH(0)'s capital resulting from the dividend. The issue price for the additional shares was satisfied by the assignment by RCI to JHH(0) on 23 September 1998 of a promissory note (PN2) issued to RCI by JHIL in partial satisfaction of the amount owing to RCI under (c) above (JHH(0) assigned PN2 back to JHIL on 28 September, in partial payment of the amount it owed JHIL under PN1 and paid out the balance with a loan from James Hardie Finance Limited).
  5. On 15 October 1998, RCI transferred all its shares in JHH(0) to RCI Malta in exchange for the issue of shares in RCI Malta.

Extensive evidence was given by witnesses for RCI concerning the transactions in question and the background and context to those transactions, including the restructure of the James Hardie group that became known as 'Project Chelsea'.

This evidence established, amongst other things:

  • From about 1995, the USoperations of the James Hardie group had been profitable and the Australian operations were not (although in previous years, the situation had been the reverse) - by 1996 losses from the Australian operations (including interest expense on borrowings in Australiato fund the previously unprofitable US operations) were in the order of A$194M.
  • This resulted in economic and tax inefficiencies, with the US profits being subjected to 3 levels of taxation once they reached JHIL's Australian shareholders (i.e. profits subject to US corporate tax, dividends to Australian parent subject to US withholding tax and Australian tax payable by JHIL's Australian shareholders on unfranked dividends, since the US tax paid generated foreign tax credits for JHIL but not franking credits), which had the effect of depressing the value of JHIL's shares.
  • In addition, the Australian tax losses could not be recognised as a future income tax benefit in JHIL's consolidated accounts unless the recoupment of those losses was 'virtually certain'.
  • Accordingly, various strategies and proposals were considered by the group, from the second half of 1996, to generate assessable income in Australiato absorb the tax losses and generate Australian franking credits, including paying a dividend from the USto Australia. A dividend of US$50M was paid to RCI in March 1997.
  • While consideration was being given to payment of a further dividend, consideration was also being given to addressing the complex ownership structure of the group to deal with profit imbalance in the group and consequent tax problems. This led to the development of 'Project Chelsea', involving the restructure of the group to move the centre of operations from Australiato the US.

Scheme

The Commissioner identified a 'narrow scheme' consisting of steps (a), (b) and (c) above and alternative 'wide scheme' consisting of all of the steps (a) to (e) above.

RCI submitted that the steps relating to the dividend were not sufficiently related to the transfer of shares (the final step) for it to be properly concluded that they were part of the one scheme for the purposes of Part IVA. It contended that payment of the dividend was part of the ongoing implementation of the strategy developed in 1995 and 1996 to increase interest-bearing debt in the US and assessable income in Australia and had nothing to do with the corporate restructure of which the transfer of the JHH(0) shares was a part. RCI cited the evidence that the senior executives most involved in the dividend did not, at that time, know about the restructure proposal, that the board resolution to pay the dividend did not mention the restructure and that, at the time the dividend was declared, there had been no decision to proceed with Project Chelsea.

Her Honour found that the dividend and the share transfer wereconnected. She said that close examination of the documentary evidence supported the view that the dividend was part of the complex restructure known as Project Chelsea and was in fact an integral part of the planning of that Project from early in its inception. She also found that all of the directors and important executives were aware of Project Chelsea when the dividend was declared, and that the minutes in evidence exhibited'no doubt that the Project would go ahead'. She said it would be'naïve to assume'that there was no commitment to the Project prior to final sign-off by the board.

Like Besanko J in Futuris, Stone J rejected RCI's submission that the narrow scheme could not give rise to a tax benefit as it did not include the transfer of the shares.

Tax benefit

Stone J said the question of whether a tax benefit has been obtained in connection with the scheme requires a comparison between the scheme in question and an 'alternative postulate' (or counterfactual), on the assumption that the schemehad not been entered into or carried out. In this case it was also necessary to determine that, if the scheme had not been carried out, the greater capital gain identified by the Commissioner would have been included in RCI's assessable income.

The Commissioner's alternative postulate was that, in the absence of the scheme, RCI would still have transferred its shares in JHH(0) but the dividend would not have been paid so as to reduce the value of the shares (or rather only the cash dividend of US$20M from revenue profits would have been paid and the issue of 570 additional shares in JHH(0) under step (d) above would not have occurred), with the result that the market value of RCI's shares in JHH(0) when they were transferred to RCI Malta would have been greater by the amount of US$318M.

Stone J rejected RCI's submissions that, without the benefit of the dividend, the transfer of its shares in JHH(0) could not reasonably be expected to have taken place, saying that RCI invited the Court to draw this inference 'seemingly as a matter of commercial logic' and did not provide any evidence to support it. On the other hand, she said, there was 'a wealth of evidence' that Project Chelsea would have proceeded, being the means selected by the JHIL Board to address the concerns about the profit imbalance between the Australian and US operations of the group (which her Honour found to be ongoing, with no real expectation that it would be reversed). This required the operations to be re-arranged so as to be concentrated in the US, of which the transfer of RCI's shares in JHH(0) was a part.

Stone J also rejected RCI's submission that it could not reasonably be expected that JHIL would have put to its shareholders a proposal that would carry with it a tax liability in the amount calculated by the Commissioner, as there was no evidence to support this submission. She accepted that it must be inferred from RCI's failure to lead evidence from any of its witnesses about the alternatives to the disposal of RCI's shares in JHH(0) available to the group, that such evidence would not have assisted it.

In short, Stone J found that RCI failed to discharge its onus of proving that the Commissioner's alternative postulate was unreasonable or that there was a more reasonable alternative that did not involve the sale of the shares. Her Honour clearly did not consider such an alternative postulate to be 'as a result of any objective inquiry of the, inevitable'.1

Dominant purpose

Stone J concluded, having regard to the factors in s 177D(b), that the parties entered into or carried out the scheme, or part of it, with the dominant purpose of enabling RCI to obtain a tax benefit in connection with the scheme.

Her Honour had regard in particular to the manner in which the scheme was entered into, the form and substance of the scheme and the fiscal and financial consequences of the scheme for the relevant companies. She clearly considered the creation of the revaluation reserve and the means of payment of the dividend out of that reserve to be contrived, if not artificial, and the quantum and manner of payment of the dividend to be 'unusual', with no commercial justification.

Among other things, her Honour noted the following:

  • That the quantum of the dividend resulted in JHH(0) being so severely undercapitalised that it was in danger of breaching the US thin capitalisation rules and had to be partially recapitalised by RCI subscribing for additional shares in the order of US$50M;
  • The dearth of evidence of any substance to the board of JHH(0) about the revaluation and dividend, which she said was 'in stark contrast' to the 'detailed planning and consideration' which characterised the planning for Project Chelsea;
  • The complex arrangements for the payment of the dividend, with only a small portion to be paid by cash and the balance by inter-company loans;
  • That there was no evidence of the directors of JHIL considering the proposal that it should lend US$298M to JHH(0), which as a result of the dividend was suffering severe financial stress;
  • That the evidence suggested that there was constant concern in the period leading up to the payment of the dividend as to the CGT implications of the low cost base of RCI's shares in JHH(0); and
  • Contrary to RCI's submissions, there were significant differences between the dividend paid in 1997 and the 1998 dividend, including that the 1997 dividend was paid in cash with money borrowed from external lenders, with the cash being placed on deposit in Australiato generate interest income to absorb the Australian losses. This, she said, indicated that the 1997 and 1998 dividends were 'motivated by different concerns'.

British American Tobacco Australia Services Limited v Commissioner of Taxation [2010] FCAFC 130 ('BAT')

This was a decision of the FFC (Dowsett, Jessup and Gordon JJ), handed down on 10 November 2010, on the taxpayer's appeal against the decision of Emmett J at first instance in British American Tobacco Australia Services Ltd v Commissioner of Taxation 2009 ATC 20-155, handed down on 21 December 2009.

This case concerned the application of Part IVA to include an amount of approximately $118M in the assessable income of British American Tobacco Australia Services Ltd (formerly called WD & HO Wills (Australia) Ltd) (BAT) in the year ended 30 June 2000 in respect of a transaction in connection with the global merger of the British American Tobacco group of companies (BAT Group) with the Rothmans International group of companies (Rothmans Group).

Both the Federal Court and the FFC dismissed BAT's appeal.

Facts

The alleged tax benefit was said to arise out of the disposal of certain Australian intellectual property assets of BAT (the 9 Wills Brands) to Rothmans of Pall Mall (Australia) Limited (Rothmans) (a wholly owned subsidiary of the head company of the Rothmans Group in Australia, Rothmans Holdings Limited (Rothmans Holdings)) for a price equal to their market value and the immediate on-sale of those assets by Rothmans to subsidiaries of Imperial Tobacco Group plc (Imperial) for the same price. The disposal to Imperial of the 9 Wills Brands, along with certain brands held in the Rothmans Group, was necessary to satisfy an undertaking given to the Australian Competition and Consumer Commission (ACCC) in order to avoid the ACCC intervening to prevent the merger in Australia.

Completion of the schemes of arrangement that gave effect the merger of the BAT and Rothmans Groups in Australia occurred on 2 September 1999, at which time BAT became a wholly owned subsidiary of Rothmans Holdings. The sale of the 9 Wills Brands to Rothmans occurred on 3 September 1999, pursuant to irrevocable offers under 'Offer Instruments' entered into between BAT, Rothmans and Imperial in July 1999, such that the CGT event in respect of the transfer of the 9 Wills Brands from BAT to Rothmans occurred when BAT was a member of the same wholly owned group as Rothmans.

As a result, BAT and Rothmans were entitled to, and did, choose to apply the CGT roll-over under former Subdivision 126-B of the Income Tax Assessment Act 1997 (Cth) (1997 Act) in respect of the capital gain arising for BAT on the sale of the 9 Wills Brands to Rothmans.

In addition, Rothmans was able to offset the capital gain arising for it on the subsequent transfer of the 9 Wills Brands to Imperial with its own carried forward net capital losses and net capital losses transferred to it under former Subdivision 170-B of the 1997 Act by Rothmans Holdings and Rothmans Asia Pacific Limited (Rothmans Asia), which had arisen on the pre-merger disposal of their shares in an Indonesian subsidiary. These capital losses could not have been utilised by BAT under the relevant provisions.

The need to transfer the 9 Wills Brands to Imperial had become clear soon after the worldwide merger of the BAT and Rothmans Groups had been announced in January 1999. A Term Sheet was signed on behalf of British American Tobacco plc and Imperial on 30 April 1999, providing for the sale to Imperial of a number of Australian and New Zealandbrands, some of which were Wills brands and some of which were Rothmans brands. The Term Sheet identified BAT and Rothmans Holdings as the sellers of the Australian brands, but provided that the parties would 'work together to achieve an efficient structure' for the transactions.

Various internal memoranda were prepared in May 1999 concerning a proposal for the 9 Wills Brands to be sold from BAT to Rothmans after completion of the merger and on-sold by Rothmans to Imperial, enabling BAT to access CGT roll-over relief in respect of the capital gain arising for it in respect of the 9 Wills Brands and Rothmans to utilise the capital losses available to the Rothmans Holdings group against the capital gain arising for it on the on-sale of those Brands to Imperial.

Scheme

The Commissioner identified the scheme as consisting of:

  • The decision tointerpose Rothmans between BAT and Imperial in relation to the disposal of the 9 Wills Brands from BAT to Imperial;
  • The disposal of the 9 Wills Brands from BAT to Rothmans;
  • The disposal of the 9 Wills Brands from Rothmans to Imperial;
  • The making of the choices by BAT and Rothmans to obtain rollover in relation to the capital gains made by BAT as a result of the disposal of the 9 Wills Brands to Rothmans; and
  • The making of agreements for the transfer of net capital losses from Rothmans Holdings and Rothmans Asia to Rothmans and the utilisation by Rothmans of its own and the transferred capital losses in calculating its net capital gain for the 2000 year of income.

Emmett J and the FFC accepted the scheme as identified by the Commissioner and rejected BAT's submission that the relevant scheme consisted solely of making the roll-over choice because the other steps did not result in the tax benefit and therefore could not be part of the scheme. The FFC found that the steps before and after the roll-over choice werea part of the scheme and were not 'merely context'. Accordingly, s 177C(2A)(a) did not apply to prevent a tax benefit from arising, as the requirement in s 177C(2A)(a)(ii) that the scheme must consist of only of the making of the roll-over choice was not satisfied.

Tax benefit

The counterfactual posited by the Commissioner was that, in the absence of the scheme, the 9 Wills Brands would have been sold directly by BAT to Imperial, resulting in an assessable capital gain for BAT that could not be the subject of a CGT roll-over.

Emmett J found that there was no reason to doubt that, if the scheme had not been implemented, the 9 Wills Brands would nevertheless have been disposed of by BAT direct to Imperial in order to satisfy 'what was perceived to be necessary for the completion of the merger' and found that there was 'no legal or commercial reason' why the 9 Wills Brands could not have been transferred by BAT directly to Imperial.

While BAT had put forward various commercial reasons for the interposition of Rothmans in the transactions (including that it was logistically simpler to have a single vendor of all the brands being transferred to Imperial), Emmett J clearly did not find these compelling.

Dominant purpose

BAT contended that:

  • the dominant purpose of all the parties involved in the scheme was to allow the merger of the BAT Group and the Rothmans Group to proceed by bringing about the disposal of brands to Imperial and thereby preventing intervention by the ACCC;
  • the fact that that purpose was effected in a way that utilised capital losses that were properly available to the merged group (and arose in connection with the merger) does not transform it into a purpose of obtaining a tax benefit; and
  • the scheme was an ordinary transaction entered into or carried out for the dominant purpose of successfully completing the merger.

Emmett J said these contentions ignored the 'essence' of the scheme, being the disposal of the 9 Wills Brands by BAT to Rothmans and their subsequent disposal by Rothmans to Imperial, coupled with the exercise of the roll-over choice and the utilisation of the Rothmans Holdings group's capital losses. He said there was no commercial or legal reason why the disposition to Imperial of both the 9 Wills Brands and the Rothmans brands should have been effected from a single vendor rather than separate vendors and that 'precisely the same commercial and legal object' (namely satisfying the requirements of the ACCC to allow the merger to proceed) could have been achieved without the transfer by BAT to Rothmans followed by the transfer by Rothmans to Imperial.

In short, as the FFC said, Emmett J found that it was unnecessary to implement the scheme (as opposed to the counterfactual) to achieve the overall commercial benefits.

Emmett J considered each of the 8 matters in s 177D(b) and found that it would be concluded, having regard to those matters, that the dominant purpose of those who entered into and carried out the scheme was to enable BAT to obtain the tax benefit of avoiding tax on the capital gain on the sale of the 9 Wills Brands.

The FFC held that Emmett J had not erred in the way he approached the exercise of concluding the dominant purpose under s 177D(b). Their Honours pointed out that this exercise usually requires that the scheme as carried out be compared with the counterfactual, which in this case clearly pointed to a dominant purpose of obtaining the tax benefit.

Both Emmett J and the FFC clearly considered the timingof the transactions (i.e. deferral of the CGT event until after completion of the merger, through the mechanism of the Offer Instruments) to be an important factor in the conclusion of dominant purpose in this case. It is interesting to note that, if the case had occurred today, in the environment of tax consolidation, the interposition of the sale to Rothmans and the CGT roll-over would not have been necessary and any tax benefit would have arisen purely from deferring the sale to Imperial until after the merger, when BAT would presumably have become a member of the same tax consolidated group as the Rothmans companies.

Commissioner of Taxation v AXA Asia Pacific Holdings Limited [2010] FCAFC 134 ('AXA')

This was a decision of the Full Federal Court (Dowsett, Edmondsand Gordon JJ), handed down on 18 November 2010, on the Commissioner's appeal against the decision of Jessup J at first instance in AXA Asia Pacific Holdings Limited v Commissioner of Taxation [2009] FCA 1427 (handed down on 4 December 2009).

It concerned the disposal by AXA Asia Pacific Holdings Limited (AXA) of its wholly owned subsidiary, AXA Health Insurance Pty Limited (AXA Health) to Macquarie Health Fundco Pty Ltd (MHF), a special purpose subsidiary of Macquarie Bank Limited (MBL) on 30 August 2002 for $570M, paid partly in cash and partly by the issue to AXA of approximately $383M of convertible preference shares in MHF's direct parent, Macquarie Health Acquisitions Pty Limited (MHA) (which was 99% owned by MBL). AXA claimed partial roll-over relief under the scrip for scrip provisions in Subdivision 124-M of the 1997 Act.

The Commissioner issued an amended assessment to AXA for the year ended 31 December 2002, disallowing the roll-over under ss 124-780(4) and (5) on the basis that the parties were not dealing with each other at arm's length and, in the alternative, pursuant to a determination under Part IVA to include in AXA's assessable income the amount of the assessable capital gain that would have arisen for AXA on the disposal of its shares in AXA Health in the absence of the scheme and the roll-over.

At first instance Jessup J upheld AXA's appeal against the Commissioner's decision to disallow the objection. The FFC, by majority (Edmondsand Gordon JJ), dismissed the Commissioner's appeal against the decision of Jessup J in relation to both s 124-780 and Part IVA. Dowsett J, dissenting, allowed the Commissioner's appeal on the grounds that the parties were not dealing at arm's length but agreed with the majority's decision and reasons in relation to Part IVA.

Facts

In 2000 AXA decided that its health insurance business, conducted by AXA Health, was not sustainable in the long term and undertook a strategic review of its options. At the end of 2000, AXA decided that its best option for AXA Health was either a merger with Medicare Benefits Fund of Australia Ltd (MBF) or a sale of the business to MBF. In early 2001, AXA engaged MBL's advisory arm (MBL Advisory) to assist it in its approach to MBF.

When it became apparent that the negotiations with MBF may not be successful (because MBF was not prepared to offer the price that AXA wanted) and that there were no other interested buyers, MBL Advisory started examining an initial public offering (IPO) or leveraged buy-out (LBO) as alternatives to a sale and referred it to the MBL Principal Transactions Group (MBL PTG), which might be interested in participating in an LBO. MBL had also had discussions with British United Provident Insurance Limited (BUPA).

In March and April 2002, MBL PTG made a non-binding bid for the acquisition of AXA Health by the newly established special purpose company, MHA for a minimum price of $560M, including a cash deposit and the balance by way of convertible 'vendor shares' in MHA. The bid made it clear that MBL was not a long term owner and provided for AXA to participate in any profits on a subsequent divestment of AXA Health. It also provided for MBL to be paid an underwriting fee of $10M. MHF was later incorporated into the structure.

In May 2002, MBL and a BUPA subsidiary, BUPA Australia Pty Limited (BAPL), incorporated MB Health Holdings Pty Limited (MB Health) as a consortium vehicle, owned as to 50% each by MBL and BAPL. On 30 May 2002 MBL, BUPA, BAPL and MB Health entered into an Equity Participation Agreement, under which MB Health would acquire AXA Health, either by exercise by AXA of a put option or by acquisition of MHF from MHA and BAPL to MBL granted put and call options over the shares in MB Health.

Also on 30 May, MBL made another offer for AXA Health, which was accepted by AXA on 3 June.

On 4 June 2002, MBL, MHA and AXA entered into the Underwriting Agreement, which provided for the sale of AXA Health to MHA for $570M, including a non-refundable cash deposit of $57.6M and the balance by way of convertible vendor shares in MHA. MBL also granted AXA a put option over the vendor shares and, in the event that AXA converted the vendor shares into ordinary shares in MHA, a call option over the ordinary shares in MHA. That Agreement also provided for an underwriting fee of $5M to be paid to MBL by AXA.

At the same time an Equity Sell Down Agreement was entered into by AXA, MBL and MHA, providing for AXA to participate in any profit on on-sale of AXA Health and to pay an equity sell down fee of $5M to MBL.

In August 2002, the Underwriting Agreement was amended to enable MHA to direct AXA to transfer the shares in AXA Health to MHF and the MHA Undertaking was entered into between MHA and MHF, under which MHF was to issue $240M of shares to MHA and pay deferred consideration of $330M on the earlier of the date on which AXA converted its vendor shares in MHA and another date (a total consideration of $570M), in return for MHA directing AXA to transfer the AXA Health Shares to MHF and providing the purchase consideration to AXA.

At the same time, a Consortium Acquisition Agreement was entered into between MHA and MB Health, under which MHA was to sell MHF to MB Health, subject to a condition precedent that AXA was no longer able to exercise the put option granted by MB Health in relation to the vendor shares in MHA (i.e. if AXA gave notice to convert the vendor shares).

Completion of the sale of AXA Health to MHF occurred on 30 August 2002.

On 7 February 2002, AXA gave notice of conversion of its vendor shares in MHA, effective 28 February 2003, and that it would exercise all of the call options granted by MBL and MHH over MHA. This triggered the Consortium Agreement, such that MB Health acquired MHA's shareholding in MHF for $240M and MHF paid the deferred consideration (as adjusted) of $317.85M to MHA.

The end result was that, as at 28 February 2003:

  • AXA owned all of the ordinary shares in MHA;
  • MHA's only asset was cash of $557.85M (i.e. $240M plus $557.85M); and
  • MB Health owned MHF, which owned AXA Health.

Scheme and tax benefit

The Commissioner identified the scheme as consisting of: the establishment by MBL of the corporate structure to acquire AXA Health; the establishment of MB Health, the issue of the vendor shares to MHA (with special rights attached so that they did not constitute a 'significant stake' under s 124-783(1)); the agreements and steps taken on 28 February 2003 to complete the sale of AXA Health to MB Health; and AXA choosing to obtain the CGT roll-over.

The only counterfactual on which the Commissioner ultimately sought to rely was that, in the absence of the scheme, AXA would have sold AXA Health directly to MB Health for cash.

The Commissioner relied on a number of factors to show that this was a reasonable counterfactual, including: BUPA Board's resolution of 9 May 2002 to acquire AXA Health; the Equity Participation Agreement of 30 May 2002 for the purchase of AXA Health by MB Health and the put and call options over the shares in MB Health granted by MBL and BUPA; BUPA's request in July 2002 for FIRB approval for MB Health to acquire AXA Health (which was granted in August); the fact that, under the Shareholders Agreement of 25 August 2002, from the date of MHF's acquisition of AXA Health, those companies were treated as subsidiaries of MB Health and had the same directors as MB Health and MB Health took over the management of AXA Health; and that at no time was MBL exposed to the risks and rewards associated with the ownership of AXA Health.

Jessup J, found that it was notreasonable to expect that AXA Health would have been sold directly to MB Health. This was based on the evidence of Mr Facioni, an MBL executive primarily responsible for arranging the deal, to the effect that MBL would not have been prepared to enter into any arrangement that did not provide for the fees totalling $10M payable to MBL under the Underwriting and Equity Sell Down Agreements, which would not have been entered into under the counterfactual. His Honour found that MBL would not have participated in a transaction involving a direct sale to MB Health without the fees, in which case the transaction would not have proceeded.

The FFC held that, on the objective facts before the trial judge, AXA had demonstrated that the Commissioner's alternative postulate was not sufficiently reliable to be regarded as reasonableand therefore had discharged its onus of proving that it did not obtain a tax benefit. They said the trial judge was entitled to rely on Mr Facioni's evidence in this regard.

The FFC said the Commissioner's submission that MBL could have earned the same fees under the alternative postulate was inconsistent with Mr Facioni's evidence.

It is not clear whether AXA was only prepared to pay the fees under the scheme because of the tax saving.

Dominant purpose

Neither the trial judge nor the FFC found it necessary to consider the issue of dominant purpose, given their finding that there was no tax benefit.

Conclusion

These cases illustrate the importance of the taxpayer's onus of proof in relation to the tax benefit and counterfactual. The taxpayer must show, either by positive evidence or as a matter of logical inference, that the counterfactual posited by the Commissioner, or any counterfactual that would give rise to a tax benefit, is not reasonable. This generally requires the taxpayer to establish what it would or might reasonably be expected to have done in the absence of the scheme. The taxpayers in Futuris and AXA were able to discharge this onus but those in RCI and BAT were not.

Futuris, RCI and BAT also confirm that it can be concluded under s 177D(b) that the scheme was entered into for a dominant purpose of enabling the taxpayer to obtain a tax benefit, even if the wider arrangement of which the impugned transactions form a part clearly had a commercial purpose. This is consistent with decisions such as FC of T v Spotless Services (1996) 186 CLR 404 and FC of T v Hart (2004) 217 CLR 216.

The conclusion in relation to dominant purpose usually requires comparison of the actual scheme with the 'counterfactual' or 'alternative postulate'. While the mere fact that a tax benefit arises under the scheme is not enough (as made clear in Hartand other cases), if the difference between the counterfactual and the scheme is explicable only by the tax benefit, then a conclusion that the dominant purpose was to obtain a tax benefit will usually follow, unless the scheme can be said to be an 'ordinary' commercial transaction that is not artificial or contrived. As a general rule, compelling commercial reasons for entering into the particular scheme rather than the counterfactual will need to be shown.

This is particularly so in cases where the scheme involves particular steps in an otherwise commercial transaction that result in a reduction in a tax benefit as compared to the counterfactual, as in each of the above cases. In Futuris, these were the steps that had the effect of increasing the cost base of Futuris's Walshville shares, thus reducing the capital gain on their disposal in the public float. In RCI, they were the asset revaluation and dividend steps that reduced the market value of RCI's shares in JHH(0) and reduced the capital gain on the transfer of those shares, which was part of the restructure of the James Hardie group. In BAT, it was the interposition (and timing) of the sale of the 9 Wills Brands to Rothmans rather than a direct sale to Imperial, thus enabling a CGT roll-over to be obtained and capital losses utilised. In AXA, it was the interposition of the sale of AXA Health to MHF in exchange for shares, for which the scrip for scrip roll-over was available, as opposed to a direct sale to MB Health for cash, for which no roll-over would have been available.

In RCI and BAT¸ it was found that there was no commercial rationale for these additional steps and that Part IVA applied. In Futuris, while it was found that the only reasonable counterfactual did not give rise to a tax benefit for the taxpayer, the judge said that, if there had been a tax benefit, he would have concluded that the dominant purpose was to obtain the tax benefit, largely because of the artificiality and lack of apparent commercial rationale for the steps in question. In AXA, on the other hand, the counterfactual was found not to be reasonable because of the lack of fees for MBL.

Futuris and RCI are currently under appeal to the FFC. It is not yet known whether special leave to appeal to the High Court will be sought by the taxpayer and Commissioner, respectively, in BAT and AXA.

Finally, it should be noted that the transactions in Futuris, RCI and BAT all occurred before the introduction of the tax consolidation regime (while those in AXA occurred while the legislation was still in draft form)


1 Refer FC of T v Trail Bros Steel & Plastics Pty Ltd [2010] FCAFC 94 at [36], where Dowsett and Gordon JJ observed that 'it is also conceivable that a taxpayer may not lead positive evidence of an alternative postulate because, for example, the result of any objective enquiry of the alternative postulate is inevitable'.
Important Disclaimer: The material contained in this article is comment of a general nature only and is not and nor is it intended to be advice on any specific professional matter. In that the effectiveness or accuracy of any professional advice depends upon the particular circumstances of each case, neither the firm nor any individual author accepts any responsibility whatsoever for any acts or omissions resulting from reliance upon the content of any articles. Before acting on the basis of any material contained in this publication, we recommend that you consult your professional adviser. Liability limited by a scheme approved under Professional Standards Legislation (Australia-wide except in Tasmania).

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