CHANNEL PASTORAL HOLDINGS PTY LTD v FC of T

Judges: Allsop CJ
Edmonds J
Gordon J
Pagone J

Davies J

Court:
Full Federal Court, Sydney

MEDIA NEUTRAL CITATION: [2015] FCAFC 57

Judgment date: 7 May 2015

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Davies J

136. I have had the advantage of reading a draft of the joint reasons of Edmonds and Gordon JJ and a draft of the judgment of Pagone J. I agree with the reasons and conclusions of Pagone J that all three questions should be answered " no " and make some additional observations.

137. The decision of the majority in Macquarie (Full Court) does not give effect to the provisions of Div 701 of the 1997 Act in the context of the application of Pt IVA of the 1936 Act. The majority concluded that the subsidiary company in that case (Mongoose) could not be the subject of direct application of either s 177C or s 177F. Their Honours reasoned that whilst Mongoose was a " taxpayer " for the purposes of Pt IVA, a determination under s 177F could not be made to it because, by virtue of Pt 3-90, the subsidiary was not liable to be assessed. Their Honours said at [ 133 ] :

However, it is one thing to conclude that, as a subsidiary, Mongoose technically satisfies the broad definition of " taxpayer " for the purpose of Pt IVA. It is a further - and we consider, impermissible - step to say that as a result, Mongoose in and of itself also has distinct assessable income for the purpose of the application of the provisions of Pt IVA (in particular, s 177F). In this regard, we agree with the

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respondents ' submissions to the effect that although it may technically have been a " taxpayer " , Mongoose was not liable to be directly assessed as such.

Their Honours also reasoned that Mongoose could not be the subject of the direct application of s 177C because, by virtue of Pt 3-90, Mongoose did not have assessable income. At [ 166 ] , their Honours stated:

… we do not think it permissible simply to assume that Mongoose is the relevant taxpayer for the purpose of [ the tax benefit ] analysis, as the primary judge did for the purpose of his Pt IVA analysis. By virtue of the operation of Pt 3-90, as a subsidiary, Mongoose does not have " assessable income " in and of itself, and hence cannot be the subject of direct application of s 177C, for the same reasons that we previously concluded that it cannot be the direct subject of a determination under s 177F.

In each instance, their Honours reasoned that the effect of the single entity rule in s 701-1(1) was to prevent the subsidiary from having a role in the assessability of the consolidated group: at [ 133 ] that s 701-1(1) prevented the subsidiary from having a tax benefit included in assessable income by s 177F; and at [ 166 ] that s 701-1(1) prevented the subsidiary from having assessable income for any purpose of the application of Pt IVA including the determination of the existence of tax benefit within the terms of s 177C.

138. In each case, their Honours ' reasoning failed to treat the subsidiary as " part of " the consolidated group. The reasoning assumed, rather, that the head company in a group is to be treated as if it were a separate company without the subsidiary being identifiable as part of it for any fiscal purpose. Thus at [ 164 ] their Honours explained why the alternate postulate relied on by the Commissioner for the purposes of the s 177C analysis meant that that the Commissioner had no power to make the determination to, or to assess, the head company (Macquarie). The scheme and tax benefit relied on by the Commissioner in that case were similar to the present case. The scheme identified by the Commissioner also included the step of consolidation (step (d)) and it was uncontroversial that, in the absence of the scheme, the subsidiary member (Mongoose) would, or might reasonably be expected to, have sold its assets as an independent entity and not as a subsidiary member of a consolidated group. At [ 164 ] , however, their Honours stated:

Step (d) represents the entry of Mongoose into the MBL consolidated group, as a wholly-owned subsidiary of MALLC. As the primary judge found, if the scheme had not been entered into or carried out, Mongoose would have sold the Minara shares under the Agency Proposal as an independent entity, and not as a subsidiary member of the MBL consolidated group. In those circumstances, the amount of the tax benefit - $ 318,507,469 - would not have been (and would not have reasonably been expected to be) included in MBL ' s assessable income. Rather, under this counterfactual proposed by the Commissioner, the amount of the tax benefit would have been included in Mongoose ' s assessable income in the absence of the scheme.

It may readily be accepted that Macquarie would not of itself, and indeed could not of itself, have derived assessable income from the sale by Mongoose of its shares, had the consolidated group not been formed. But s 701-1(1), as applied in the context of Pt IVA required Macquarie to be treated as including Mongoose as its part, not as if Mongoose was not included as its part. Once it is accepted that the effect of s 701-(1) is to require that the head company be taken to include each of its subsidiaries as its parts, it follows that, for the purposes of Pt IVA, the head company would have derived assessable income. Section 701-1(1) then requires the computation of the head company ' s liability for income tax to take into account the tax consequences of the actions of the subsidiary companies as " parts " of the head company for the purposes of working out the head company ' s tax liability on the group ' s taxable income, so that the calculation of the head company ' s taxable income would include any assessable income derived as the result of the actions of CCC giving rise to a liability under Pt IVA.

139.

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Their Honours ' reasoning that the effect of the single entity rule in s 701-1(1) was to prevent Mongoose from being the relevant taxpayer for the purpose of the tax benefit analysis under s 177C also impermissibly used the single entity rule beyond the purposes for which it was introduced. In considering the effect and operation of s 701(1), it is important to bear in mind that the single entity rule only applies for the purpose of working out the amount of the head company ' s tax liability or loss (as the case may be) (s 701-1(2)), and the amount of an entity ' s income tax liability or loss (as the case may be), where that entity is not a subsidiary member for the whole of an income year (s 701-1(3); s 701-1(30)). This is made clear by the express words of s 701-1(1) which state that subsidiary members of the group are taken " for the purposes covered by subsections (2) and (3) " to be parts of the head company of the group, rather than separate entities, during that period. The application of the single entity rule in s 701-1(1) does not extend beyond those purposes and cannot apply outside those purposes:
Commissioner of Taxation of the Commonwealth of Australia v Comber (1986) 10 FCR 88 at 96 [ 25 ] . Section 701-1(1) has no application in the context of the application of s 177C as the existence of a tax benefit does not, of itself, create any liability. The liability under Pt IVA is only created by a determination made under s 177F and an assessment giving effect to that determination. As the subsidiary is taken to be part of the head company for purpose of working out the head company ' s income tax liability, a determination under s 177F to the head company and assessment to that head company gives effect to Div 701 (see question 2).

140. Further, the approach taken by the majority in Macquarie (Full Court) to the application of s 177C does not give effect to the operation that section. The operation of s 177C in the application of Pt IVA is to identify what is referred to in ss 177D and 177F as " the obtaining by a taxpayer of a tax benefit in connection with a scheme " . Section 177C directs an inquiry into what would have occurred, or might reasonably be expected to have occurred, had the scheme not been entered into or carried out. That inquiry is to be approached on the basis that the scheme was not entered into or carried out. Where the scheme includes the step of joining the consolidated group, the fact of membership of the consolidated group is to be ignored for the purpose of the s 177C analysis. In Macquarie (Full Court) , as in this case, the joining of the group formed part of the scheme. Also in Macquarie (Full Court) , as in this case, the alternate postulate relied on by the Commissioner was that the subsidiary member would have sold its assets as an independent and separate company and derived a taxable gain. On that alternate postulate, the operation of Div 701 does not require that s 177C be applied in the identification of a tax benefit by the subsidiary as if the subsidiary did not have an independent existence but was part of the head company. In my respectful opinion, the majority in Macquarie (Full Court) were therefore plainly wrong to hold that by virtue of the operation of Pt 3-90 the subsidiary cannot be the subject of direct application of the s 177C analysis, and plainly wrong to hold that by virtue of the operation of Pt 3-90 a determination could not be made to the subsidiary and given effect to by an assessment to the head company (see question 1). At [ 165 ] - [ 166 ] their Honours stated:

… Rather, under this counterfactual proposed by the Commissioner, the amount of the tax benefit would have been included in Mongoose ' s assessable income in the absence of the scheme.

This inconsistency was the gravamen of the primary judge ' s comments at [ 45 ] of his reasons for judgment (as previously alluded to). We think that this issue is fatal to the Commissioner ' s submission that a tax benefit was obtained in this case, as the way in which the Commissioner has pleaded the scheme and its corresponding counterfactual clashes with both the manner in which Pt 3-90 consolidated groups are to be assessed under Pt IVA (namely, by making determinations in respect of, and issuing assessments directly to, the head company), and the clear wording of s 177C. We do not think that the words of that section offer any scope to substitute a different taxpayer purely for the purpose of that part of the analysis that relates to what

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would or might have been included in a taxpayer ' s assessable income if the scheme had not been entered into or carried out.

With respect, s 701-1(1) does not require that s 177C be applied on the basis that the subsidiary no longer exists. Rather, s 701-1(1) operates on the assumption that each of the members of the consolidated group continue to have a separate and independent existence other than for the determination of the aggregate imposition of liability. Once it is understood that the effect of Div 701 is to require the subsidiary company to be taken to be part of the head company for the purposes of assessment, it is consistent with Div 701 to assess the head company where the determination is made to the subsidiary company.

141. The provisions construed in this way operate harmoniously and permit a determination either to the subsidiary or to the head company. In each case, there could then be an assessment to the head company which, for the purposes of assessment, is deemed to include the subsidiary as part of the head company. It is only necessary for the Commissioner to rely upon ss 168 and 169 (see question 3) if Div 701 and Pt IVA do not operate in the harmonious way that has been discussed. In that event, however, the terms of Pt IVA have paramount force by virtue of s 177B of the 1936 Act and s 701-85 of the 1997 Act.