• The impact of this case on ATO policy is discussed in Decision Impact Statement: Noza Holdings Pty Ltd and Ors v Federal Commissioner of Taxation; Federal Commissioner of Taxation v Noza Holdings Pty Ltd (VID 758-763, VID 764 & VID 908 of 2009 (First Instance); VID 195-198 & VID 200-201 of 2011 (Appeal)).

FC of T v NOZA HOLDINGS PTY LTD & ANOR

Judges:
Edmonds J
Jessup J
Robertson J

Court:
Full Federal Court, Melbourne

MEDIA NEUTRAL CITATION: [2012] FCAFC 43

Judgment date: 28 March 2012

---

Edmonds, Jessup and Robertson JJ

The Court:

Introduction

1. For all the underlying complexity of the issues raised by these appeals, the ultimate issues may be shortly stated:

• (1) In the case of appeals brought by the appellant ("Commissioner") concerning Noza Holdings Pty Ltd ("Noza") (VID 195-198/2011 and VID 200/2011), whether:
  • (i) Noza is entitled, as the primary judge concluded ("first conclusion"), to a deduction of $170,983,354 in the 2003 income year (year ended 30 November 2003 in lieu of 30 June 2003), being part of a dividend of $222,655,981 that the primary judge found was declared and paid by CS (Australia) Pty Ltd ("CSA") to CS Financing I LLC ("CSF") in that income year, pursuant to s 25-90 of the Income Tax Assessment Act 1997 (Cth) ("the 1997 Act");
  • (ii) in the alternative, whether, having regard to the terms upon which the preference shares in CSA were issued to CSF, Noza is entitled, as the primary judge concluded ("alternative conclusion"), to a deduction of $83,001,628 in each of the 2003-2005 income years pursuant to s 25 90 of the 1997 Act?
• (2) In the case of the appeal brought by the Commissioner concerning ITW AFC Pty Limited (ldquo;AFC") (VID 201/2011) whether, having regard to the terms upon which the preference shares in AFC were issued to CSA, AFC is entitled, by reason of the primary judge's alternative conclusion, to a deduction of $83,001,628 in the 2002 income year (year ended 30 November 2002 in lieu of 30 June 2002) pursuant to s 25 90 of the 1997 Act?

2. There are a number of difficult anterior issues that have to be addressed and answered to enable one to reach a reasoned conclusion on the ultimate issues and these explain the description "underlying complexity". They are addressed and answered in ordered sequence below.

3. Before the primary judge, the Commissioner contended, in the alternative, that to the extent any amount was deductible to Noza or AFC, Pt IVA of the Income Tax Assessment Act 1936 (Cth) ("the 1936 Act") applied to cancel the tax benefit represented by that deduction. The primary judge rejected this contention. The Commissioner abandoned reliance on Pt IVA in his amended notices of appeal.

4. Because of the Commissioner's reliance on Pt IVA before the primary judge, it was incumbent on her Honour to take a wide view of the relevant factual background, and her Honour made relevant observations and findings with respect to this background at [15]-[130] of her Reasons for Judgment ("Reasons") that are no longer directly relevant to the issues on the appeals.

5. Nevertheless, there are background and transactional facts on which her Honour did make findings which are still relevant and it will be helpful to the reader if they are set out early in these reasons. Subject to the Commissioner's submissions regarding the validity of the dividends declared in 2003 and the enforceability of the promissory note, the Commissioner does not dispute the facts as found. The summary of the facts below is largely taken from Annexure A to the Commissioner's outline of submissions.

The facts

The taxpayers

6. At all relevant times, the taxpayers were Australian resident companies and members of the ITW Group of which Illinois Tool Works Inc ("ITW Inc"), a United States ("US") corporation listed on the New York Stock Exchange, was the ultimate holding company.

7. AFC was incorporated in Victoria, was a wholly-owned subsidiary of CSA, an Australian company, and itself wholly owned Solutions Group Transaction Subsidiary Inc ("SGTS"), a US resident Delaware company.

8. Noza was incorporated in Victoria and its immediate holding company was ITW (EU) Holdings Ltd; its ultimate holding company was ITW Inc.

9. At the commencement of the 2003 income year (namely, 1 December 2002), Noza became the head company of a Multiple Entry Consolidated ("MEC") group pursuant to Division 719 of Pt 3-90 of the 1997 Act, such group including AFC and CSA: (Reasons [10]).

10. The relevant taxpayer for the 2002 income year was AFC whilst the relevant taxpayer for the 2003-2005 income years was Noza, in its capacity as the head company of the MEC group.

Background

11. In 2001, ITW Inc and its wholly-owned subsidiaries (referred to herein as "the ITW Group") operated some 600 businesses in 40 countries, principally concerned with the manufacture and sale of consumer and industrial products. At this time, the ITW Group held more than 17,000 patents and pending applications worldwide and it adopted a practice of working closely with its customers to understand and meet their needs (defined as customer-based intangibles): (Reasons [1]-[3]).

12. In 2001, the ITW Group entered into a series of transactions designed to centralise ownership of its customer-based intangibles and crystallise their value, thereby facilitating any future legal action for their protection and giving rise to state tax savings in the US: (Reasons [4]). This involved, broadly, the creation of various royalty income streams and their transfer for value between companies in the ITW Group: (Reasons [31], [56], [126]-[130]).

13. The following paragraphs focus on the issue of preference shares (or preferred stock, to adopt the US terminology, in the case of US companies) by companies within the ITW Group and the later declaration and payment of dividends on those shares.

The issue of the preference shares

14. On 15 November 2001, the ITW Group entered into four relevant transactions: (Reasons [126]-[130]).

15. First, CSF, a US resident Delaware company, subscribed for 941 fully paid redeemable preference shares that were issued by CSA ("CSA Preference Shares"). The CSA Preference Shares had a total issue price of $1,927,700,000 (being the AUD equivalent of US$1 billion on 15 November 2001). CSF issued a US$1 billion demand note to CSA to pay for the CSA Preference Shares. After a period of five years, the CSA Preference Shares were to be redeemed for $1,813,965,700 plus an amount equal to any unpaid dividends and any unpaid default dividends: (Reasons [126]).

16. The terms of the CSA Preference Shares provided for the dividends on a cumulative preferential basis at the rate of 6% per annum on the capital paid-up on each preference share. The unpaid dividends were to accumulate annually. The redemption value was less than the issue price. The difference between the redemption value and the issue price was to be offset by the higher dividend rate of 6% such that the effective yield on the CSA Preference Shares was expected to be 4.5757%, the then market yield for such preference shares: (Reasons [126]).

17. Clause 3.1 of the terms of issue of the CSA Preference Shares provided that:

"Each Redeemable Preference Shareholder will be entitled to receive out of the profits of the Company a Dividend, in respect of each Redeemable Preference Share held by that Redeemable Preference Shareholder, annually on 15 November of each year, in priority to the dividend entitlements of any other class of shares (other than Senior Shares)."

18. Clause 3.2 provided that:

"Where a Redeemable Preference Shareholder is entitled to a Dividend in respect of a Redeemable Preference Share, if the profits of the Company in any year are insufficient to cover the amount of the Dividend for that year, or where the directors resolve not to pay that Dividend or otherwise fail to declare the Dividend, when the entitlement arises under clause 3.1 of these Terms, then:

• (a) the unpaid amount of the Dividend (to which the Redeemable Preference Shareholder would have been entitled under clause 3.1 of these Terms) will be carried forward to the following year and such Unpaid Dividend will be paid when the Company next declares a Dividend out of profits of the Company, in priority to the Dividend in respect of the subsequent year or years; and
• (b) a Default Dividend will be payable in respect of any Unpaid Dividend calculated at the rate of 4.5757% per annum of the amount of the Unpaid Dividend from time to time. Such Default Dividend shall be calculated on the basis of a 360 day year. The Default Dividend is payable at the time the Unpaid Dividend is paid or at the time of redemption of the Redeemable Preference Shares, whichever is earlier."

19. The term "Unpaid Dividend" is defined by cl 1(j) as:

" Unpaid Dividend in respect of a Redeemable Preference Share means any Dividend to which an entitlement has arisen under clause 3.1 of these Terms in respect of that Redeemable Preference Share, but which has not been paid."

20. Clause 4 governs the redemption of the shares:

• "4.1 Subject to clause 4.3 of these Terms, within 45 days of the 5th anniversary of the date of issue of the Redeemable Preference Shares, or such other earlier date as the Company and the relevant Redeemable Preference Shareholder may agree, the Company must redeem each of the Redeemable Preference Shares for an amount in cash equal to the Redemption Value for the Redeemable Preference Share.
• 4.2 …
• 4.3 …
• 4.4 …"

21. The term "Redemption Value" is defined by cl 1(g) as:

" Redemption Value for each Redeemable Preference Share means the amount of A$1,927,700.00 per share plus an amount equal to any Unpaid Dividends and Default Dividends in respect of the Redeemable Preference Share."

22. Clause 5 governs the repayment of capital on winding up:

"5.1 Each Redeemable Preference Shareholder will, upon any liquidation, dissolution, winding up or where the proceeds of sale of all or substantially all of the assets of the Company are to be paid to its shareholders by way of return of capital or share buy-back (Deemed Liquidation), insofar as is permitted by any applicable law, have the right to payment of a preference payment in priority to the repayment of capital in respect of any other class of shares (other than Senior Shares). The preference payment so payable to a Redeemable Preference Shareholder shall be an amount equal to:

• (a) any Default Dividend accrued on the Unpaid Dividends;
• (b) all Unpaid Dividends; plus
• (c) A$1,927,700.00,

for each Redeemable Preference Share held by that Redeemable Preference Shareholder (together the Preference Payment).

• 5.2 …
• 5.3 …
• 5.4 …"

23. Second, CSA endorsed the US$1 billion demand note to AFC. In exchange for this, CSA subscribed for redeemable preference shares issued by AFC ("AFC Preference Shares"). The AFC Preference Shares also had an issue price of $1,927,700,000. After a period of five years, the AFC Preference Shares were to be redeemed for $1,813,965,700 plus an amount equal to any unpaid dividends and any unpaid default dividends. The AFC Preference Shares were issued on the same terms as the CSA Preference Shares, including the terms of cll 3.1 and 3.2, each of which is extracted in [17] and [18] above.

24. Third, CSF transferred the royalty income streams to AFC. In exchange for this, AFC endorsed the US$1 billion demand note (which had been originally issued by CSF) back to CSF. The US$1 billion demand note was then cancelled by CSF. AFC also issued a US$3 billion purchase note to CSF. This purchase note was to bear interest at a rate of 5.5% per annum from the date of issue until 15 November 2011. Interest was to be payable on 31 December each year commencing on 31 December 2001: (Reasons [128]).

25. Fourth, AFC transferred the royalty income streams to SGTS. In exchange, SGTS assumed AFC's obligations under the US$3 billion purchase note issued by AFC to CSF and SGTS issued 941 redeemable preference shares to AFC ("SGTS Preferred Stock"). The total issue price of the SGTS Preferred Stock was $1,927,700,000 (the equivalent of $US1 billion). Subsequent to SGTS assuming AFC's obligations under the US$3 billion purchase note, that note was cancelled and an identical note was issued by SGTS to CSF: (Reasons [129]).

26. The SGTS Preferred Stock consisted of nine Series A shares and 932 Series B shares. Each share was issued at the same price of $2,048,565 per share; the par value of each share was US$0.52, meaning the issued capital was US$489.32, not $1,927,700,000, being the price paid for the preferred stock: (Reasons [226]). The terms and conditions under which the SGTS Preferred Stock were issued are set out in a Certificate of Designation issued pursuant to s 151 of the Delaware General Corporations Law ("DGCL"), such terms and conditions including (Reasons [130]):

• (a) the shares had a five year period with maturity scheduled for 15 November 2006. The redemption value for the shares was $1,813,965,700;
• (b) preferred dividends in respect of the shares were payable annually on 15 November of each of the subsequent five years. The annual dividend rate was 6% of the redemption value, requiring total annual dividends of $108,837,942. The dividends were payable:

  "when, as and if declared by the Board of Directors, out of funds legally available therefore representing accumulated earnings of the Corporation…"

• (c) if dividends were not paid on their due date of 15 November, then the dividend payment obligation cumulated and an interest charge (at the rate of 4.5757% per annum) was payable in respect of the period in which the dividends remain unpaid. Any unpaid dividends were required to be paid on redemption of the preference shares;
• (d) at redemption time, AFC may require the preference shares to be converted into ordinary shares in SGTS instead of redeeming them; and
• (e) the only difference between the Series A and the Series B shares was that the Series A shares also gave SGTS the option to have the shares converted into ordinary shares in SGTS at redemption time. The Series B shares were only convertible at the option of AFC.

Declaration and payment of dividends

27. On 15 November 2002, the first date upon which a dividend became payable under each of the CSA Preference Shares, the AFC Preference Shares and the SGTS Preferred Stock, no dividends were declared or paid by, respectively, CSA, AFC and SGTS: (Reasons [131]).

28. AFC's income tax return for the 2002 income year did not contain any claim for deductions with respect to the AFC Preference Shares; although AFC later objected to the deemed assessment and contended that it was entitled to a deduction for the dividends to CSA: (Reasons [132]).

29. As noted above, on 1 December 2002, Noza became the head company of a MEC group that included AFC and CSA. The effect of the relevant provisions of Div 719 of Pt 3 90 of the 1997 Act was that, as a consequence of this consolidation, intra-group transactions between AFC and CSA were to be ignored for tax purposes and income received by AFC in respect of the SGTS Preferred Stock and any loss or outgoing incurred by CSA with respect to the CSA Preference Shares were deemed to be income received by Noza and a loss or outgoing incurred by Noza, respectively.

30. The next date upon which a dividend became payable under each of the CSA Preference Shares, the AFC Preference Shares and the SGTS Preferred Stock, was 15 November 2003. A number of events occurred at this time that are relevant to the issues on the appeals.

31. First, Mr Alan Sutherland, as the President of SGTS, signed a promissory note in the amount of $222,655,981 ("SGTS Promissory Note"), in satisfaction of a dividend payment by SGTS to AFC, being a dividend on the Series B SGTS Preferred Stock: (Reasons [138]). There was no meeting of the board of directors which discussed, nor resolution of the board of directors recording, the issuance of the SGTS Promissory Note: (Reasons [139]).

32. In order for SGTS to declare and pay a valid dividend under Delaware law, there were certain requirements that had to be satisfied concerning the source of the dividend. Mr Sutherland gave evidence that for the purpose of determining whether SGTS had sufficient accumulated earnings for the purposes of Art 3(a) of each Series of SGTS Preferred Stock, he made two adjustments to the accounts of SGTS which had been prepared on the basis that the Series B SGTS Preferred Stock were to be treated as debt for US GAAP: (Reasons [139], [198]-[208]). The primary judge was not satisfied on the balance of probabilities that Mr Sutherland made the adjustments: (Reasons [144]). It followed that SGTS did not have sufficient "accumulated earnings" to pay the dividend and it was paid contrary to Delaware law. Later, as at 31 December 2003, SGTS had prior year's accumulated earnings of US$26,129,369 and a current year loss of US$328,597,392: (Reasons [194]).

33. Second, SGTS and AFC entered into a Dividend Distribution Agreement, by which SGTS issued, distributed and delivered dividends in the form of the SGTS Promissory Note. The Dividend Distribution Agreement provided, inter alia, that AFC acknowledged receipt of the dividends in the form of the SGTS Promissory Note and that the provision of the SGTS Promissory Note was to be in lieu of cash and represented payment, in full, of all dividends plus accrued and unpaid interest: (Reasons [137]).

34. Third, the directors of AFC held a meeting, the minutes of which recorded that AFC had received notice from SGTS that it had declared dividends of $222,655,981 in respect of the SGTS Preferred Stock and that AFC would receive payment of the dividends in the form of a SGTS Promissory Note: (Reasons [145], [148]). The directors of AFC resolved that the dividend payable to CSA pursuant to the AFC Preference Shares be declared payable out of the profits of AFC and be paid to CSA by endorsing the SGTS Promissory Note in favour of CSA: (Reasons [146], [148]).

35. Fourth, the directors of CSA held a meeting, the minutes of which recorded that CSA resolved to accept the SGTS Promissory Note from AFC as payment of the dividends owing by AFC to CSA pursuant to the AFC Preference Shares. The minutes also record that CSA resolved:

"[T]he Dividends be declared payable out of the profits of the Company and that the Dividends be paid to CS Financing I LLC on 14 November 2003".

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

37. The SGTS Promissory Note was settled in full via an intercompany wire transfer of cash from SGTS to CSF: (Reasons [140]).

38. On 13 May 2004, the board of directors of SGTS met and resolved that the declaration and payment of the dividend by SGTS to AFC on 14 November 2003 was ratified and made the acts and deeds of SGTS: (Reasons [142], [398]).

39. None of CSA, AFC or SGTS declared or paid dividends under, respectively, the CSA Preference Shares, the AFC Preference Shares and the SGTS Preferred Stock during the 2004 or 2005 Years: (Reasons [150]). In accordance with the terms of issue of these instruments, the unpaid dividend obligations were carried forward with the applicable additional "default dividends".

SGTS' financial performance

40. In its financial reports for the 2001, 2002, 2003 and 2004 years' end, SGTS recorded net income as follows (Reasons [151]):

Year ending 30 December	Net Income (loss)
2001	US$124,877,434
2002	(US$98,748,065)
2003	(US$328,597,392)
2004	(US$36,372,348)

The statutory framework

41. We cannot improve on the primary judge's depiction of the statutory framework at Reasons [152]-[158] and therefore reproduce them here:

• "[152] Section 25-90 of the 1997 Act provides for deductibility for losses or outgoings that would, absent s 25-90, not be deductible under the general deduction provision (s 8-1 of the 1997 Act) because they were losses or outgoings incurred in deriving non-assessable income, including foreign exempt income under s 23AJ of the 1936 Act.
• [153] Section 25-90 was introduced by the New Business Tax System (Thin Capitalisation) Act 2001 (Cth). It was enacted on 1 October 2001, with retrospective effect from 1 July 2001: s 2.
• [154] Paragraph [3.7] of the Explanatory Memorandum to the New Business Tax System (Thin Capitalisation) Bill 2001 which accompanied its introduction described the new thin capitalisation regime in the following terms:

  'The new thin capitalisation regime will impose a limit on the extent to which the Australian operations of Australian outward investors can be funded by debt. Accordingly, the current limitations imposed by section 79D and section 8-1 (in relation to exempt income) on interest deductions will be removed in so far as they apply to debt deductions and do not relate to an entity's overseas permanent establishment. Therefore, expenses relating to those deductions will be able to be deducted when incurred in earning exempt foreign income and will no longer be quarantined, subject to the limits imposed by the new thin capitalisation provisions.'

• [155] Paragraph [3.11] of the Explanatory Memorandum provided that the new rules also:

  '… incorporate comprehensive concepts of debt and debt deductions that arise from debt arrangements rather than being restricted to the narrow concept of interest as in the existing rules, reflecting a move to economic form over substance.'

• [156] In general terms, s 25-90 allowed a deduction for debt deductions incurred in the derivation of exempt income. As the applicants submitted, this was a novel concept because deductions would not generally be available for expenses incurred in deriving exempt income. Section 25-90 was an exception to this general rule.
• [157] In the 2003 year (which ended 30 November in this case), s 25-90 provided:

  An *Australian entity can deduct an amount of loss or outgoing from its assessable income for an income year if :

  • (a) the amount is incurred by the entity in deriving income from a foreign source; and
  • (b) the income is exempt income under section 23AI, 23AJ or 23AK of the [1936 Act]; and
  • (c) the amount is a cost in relation to a *debt interest issued by the entity that is covered by paragraph (a) of the definition of debt deduction .

  The Taxation Laws Amendment Act (No 4) 2003 (Cth) replaced references in ss 25-90 and 23AJ from "exempt income" to "non-assessable non-exempt income". These amendments took effect as from the 2003-2004 year (that is, from 1 December 2003 for the applicants).

• [158] For an amount to be deductible under s 25-90, the taxpayer had to show that:
  • 1. the amount was a loss or outgoing incurred in the relevant year;
  • 2. the amount was incurred by the taxpayer in deriving income from a foreign source;
  • 3. the income was, in this case, a s 23AJ exempt dividend. (As at October 2001, dividends which satisfied s 23AJ were exempt income); and
  • 4. the loss or outgoing was, in this case, a cost in relation to a debt interest."

  (Emphasis added.)

42. At this point, it is appropriate to make three preliminary observations on the architecture and terms of s 25-90. First, in para (a), it refers to an amount incurred by the entity in deriving income from a foreign source. In a different statutory context the words "incurred in gaining or producing" have been understood as meaning incurred "in the course of" gaining or producing:
Ronpibon Tin NL v Commissioner of Taxation (1949) 78 CLR 47 at 56-57;
Commissioner of Taxation v Payne 99 ATC 4391; (2001) 202 CLR 93 at [9]-[13] per Gleeson CJ, Kirby and Hayne JJ;
Commissioner of Taxation v Day 2008 ATC ¶20-064; (2008) 236 CLR 163 at [22] per Gummow, Hayne, Heydon and Kiefel JJ. In Payne at [9], their Honours said:

"What is meant by being incurred 'in the course of' gaining or producing income was amplified in
Ronpibon Tin NL and Tongkah Compound NL v Federal Commissioner of Taxation where it was said that:

'to come within the initial part of [s 51(1)] it is both sufficient and necessary that the occasion of the loss or outgoing should be found in whatever is productive of the assessable income or, if none be produced, would be expected to produce assessable income.'"

In Day at [22], their Honours said:

"Their Honours' reference [in Payne at [13]] to the words 'in the course of' should not be taken to suggest a closer or more direct connection between expenditure and that which is productive of assessable income than the words of the provision themselves convey. Rather the words draw attention to the connection made necessary by the provision, which the majority considered on the facts of that case to be too remote."

43. Second, the Commissioner accepted that to the extent that any income was derived, it was from a foreign source: (Reasons [230] [transcript 8 August 2011 page 5 lines 10-11).

44. Third, the word "income" in para (a) of s 25-90 is a reference to income at general law, not to the statutory concept of assessable income under the 1936 and 1997 Acts. By virtue of the requirement in para (b), so much, perhaps, goes without saying but the point of distinction is to emphasise that the outgoing must be incurred in deriving income, not capital. When one is concerned with whether a particular receipt has the character of the derivation of income at general law, one is concerned with its quality in the hands of the recipient (
Commissioner of Taxation v McNeil 2007 ATC 4223; (2007) 229 CLR 656 at [20]) not with, where one is concerned with whether a dividend is assessable income of a shareholder in a company under s 44(1) of the 1936 Act, the source out of which the dividend is paid. As a general proposition, a gain derived from property has the character of income, particularly where the property producing the gain remains intact: McNeil at [21] and [22] in reliance on Pitney J in
Eisner v Macomber (1920) 252 US 189 at 206, 207. See the informative discourse in Parsons RW, Income Taxation in Australia: Principles of Income, Deductibility, Tax Accounting (Law Book Company, 1985) at [2.228]-[2.249], on the ordinary usage notion of a dividend as an item of income derived from property.

The primary judge's alternative conclusion

45. If the primary judge's alternative conclusion is correct, that is, that AFC in the 2002 income year, and Noza in each of the 2003-2005 income years, is entitled to a deduction of $83,001,628 pursuant to s 25-90 of the 1997 Act, it is unnecessary to consider whether her Honour's first conclusion is correct, that is, that Noza is entitled to a deduction of $170,983,354 pursuant to s 25-90 in the 2003 income year. For that reason, we propose to consider the alternative conclusion first.

46. The primary judge's alternative conclusion is articulated at Reasons [268] in the following terms:

"A liability to pay the preferred dividends annually, which were cumulative and with no restriction on the sources of funds from which they may be paid at redemption , represented a definitive commitment that accumulated in each year of income. Subject to my earlier findings at [255], [256] and [258] above, it was a commitment which constituted a "debt deduction" - an amount of interest or in the nature of interest: s 820-40(1)(a)(i). I accept the applicants' submissions that that conclusion (that the dividends which are treated as "interest" under Div 974 are deductible as they accrue) is consistent with the decision in AGC and the policy of Div 974 which sought to align the form and substance of instruments: see Explanatory Memorandum, New Tax System (Debt and Equity) Bill 2001, pg 9."

47. Her Honour's earlier findings at [255], [256] and [258] went only to quantum. The reference to "AGC" is to
Commissioner of Taxation v Australian Guarantee Corporation Ltd 84 ATC 4642; (1984) 2 FCR 483.

48. On the hearing of the appeals, the Commissioner assailed the primary judge's alternative conclusion as being incorrect on three bases:

• (1) First, that the terms of the AFC and CSA Preference Shares which, as noted in [23] above, are the same, relevantly cll 3.1, 3.2, 4.1, 5.1, and the definition of the terms "Unpaid Dividend" and "Redemption Value" in cll 1(j) and (g) respectively (see [17] to [22] above) did not themselves give rise to a presently existing liability to pay. According to the Commissioner, the existence of any such liability is conditional on:
  • (i) The existence of sufficient profits in AFC (2002 income year) or CSA (2003 to 2005 income years) to pay a dividend out of profits; and
  • (ii) a resolution/declaration by the directors of AFC or CSA to declare a dividend.
• (2) Secondly, potential cumulation of the obligation is irrelevant. Dividend entitlements under the AFC and CSA Preference Shares "cumulate" in the sense that if no entitlement to a dividend arises in one year an entitlement to that same dividend may arise in a subsequent year, again subject to the existence of profits in that subsequent year and the declaration of a dividend in that subsequent year: see cl 3.2(a). However, the Commissioner contends that potential liability in a later year is not relevant to the question whether there was a presently existing liability in an earlier year.
• (3) Thirdly, the obligation to pay an amount equal to any Unpaid Dividends at maturity as part of the Redemption Value was not unrestricted but subject to applicable laws, including ss 254J and 254K of the Corporations Act 2001 (Cth) (Corporations Act), and even if it were it would not bear upon the issue whether a previous liability existed in a prior year.

49. The terms of the AFC and CSA Preference Shares are not a model of clarity and that observation is as pertinent to cl 3 (see [17] and [18] above) as it is to other clauses. Nevertheless, the various components of cl 3 must be read in context. So read, cl 3.1 makes it clear that a shareholder's entitlement to a dividend is an entitlement to receive it out of the profits of the company. This is consistent with cl 28.5 of the Constitution of CSA which provides "Dividends may only be paid out of the profits of the Company". Further, cl 28.1 of the Constitution provides: "The power to declare dividends (including interim dividends) is vested in the Directors who may fix the amount and timing of any dividend in accordance with this Constitution". It will be recalled that s 254V(2) of the Corporations Act provides that if the company has a constitution and it provides for the declaration of dividends, the company incurs a debt when the dividend is declared: see generally
Bluebottle UK Limited v Deputy Commissioner of Taxation 2007 ATC 5302; (2007) 232 CLR 598.

50. On what we think is the proper construction of the terms of the AFC and CSA Preference Shares, a shareholder has no entitlement to receive a dividend and the relevant company, AFC or CSA as the case may be, has no obligation to pay it until it has been declared. Until that event occurs, the company has no "presently existing liability" to use the language of Gibbs J (as his Honour then was) in
Nilsen Development Laboratories v Commissioner of Taxation 81 ATC 4031; (1981) 144 CLR 616 at 627; nothing has been incurred.

51. The primary judge's reliance on AGC and the legislative policy of Div 974 is something, with the greatest respect, we have difficulty with. In AGC a Full Court of this Court concluded that a presently existing liability to pay interest was incurred in each year pursuant to a deferred interest debenture. In reaching this conclusion the Court relied principally on two matters: first, the common law rule that interest ordinarily accrues on a loan on a day to day basis was not displaced by the wording of the debenture which referred to interest only being earned on redemption (at 497-498 per McGregor J, 505-507 per Beaumont J); and, secondly, that on the proper construction of the instrument there were no conditions to the incurring of an interest obligation in each year.

52. AGC is distinguishable from the present case on two bases:

• 1. the present case concerns dividends payable on preference shares, not interest on a debenture, and there is thus no scope for the operation of the common law rule concerning the day to day accrual of interest on a loan; and
• 2. in the present case the incurrence of the obligation was subject to conditions concerning profitability and a resolution of directors, and those conditions went to the existence of the entitlement and not merely the time of payment. In this respect, it is closer to the decision in
  Emu Bay Railway Company Ltd v Commissioner of Taxation (1944) 71 CLR 596.

53. Finally, we do not regard the obligation on redemption to pay the Redemption Value and the fact that it includes an amount equal to any Unpaid Dividends as reflecting on the issue of whether a present liability existed in a prior year. The liability must exist during the relevant year, and if there is no such liability it does not matter how likely, or even certain, it is that the liability will come into existence in a future year:
Hooker Rex Pty Ltd v Commissioner of Taxation 88 ATC 4392; (1988) 79 ALR 181 at 191 per Sweeney and Gummow JJ, and the cases cited therein, especially Nilsen Laboratories at 623-624 per Barwick CJ, 632 per Mason J.

54. For these reasons, we are of the view that the terms of the AFC and CSA Preference Shares themselves do not entitle AFC in the 2002 income year or Noza in each of the 2003-2005 income years, to a deduction of $83,001,628 pursuant to s 25-90 of the 1997 Act. Without a presently existing liability for those income years there would be no loss or outgoing under that section.

55. In consequence, we turn to address the primary judge's first conclusion.

The primary judge's first conclusion

56. The primary judge's first conclusion is predicated on conclusions on four anterior issues, although one of those was conceded below and another was not an issue on the hearing of the appeals. The Commissioner conceded below that to the extent any income was derived, the dividend paid by SGTS to AFC was a dividend to which s 23AJ of the 1936 Act applied (Reasons [232]); and it was not put in issue on the appeal that the amount, if incurred, which was a cost in relation to a debt interest to which para 25-90(d) applied, was limited to $170,983,354.

First anterior issue - Whether outgoing incurred on declaration of dividend or, if not, on declaration and payment

57. The primary judge articulated the first anterior issue at Reasons [167] as follows:

"The first issue is whether CSA (and therefore Noza) incurred a loss or outgoing on 14 November 2003 (1) when CSA declared dividends of $222,655,981 payable out of profits of CSA to CSF or (2) when it declared dividends of $222,655,981 payable out of profits of CSA to CSF and then declared that those dividends be paid by endorsing the SGTS Promissory Note in favour of CSF."

(Original emphasis.)

58. The primary judge answered the first limb of the first anterior issue at Reasons [183]-[185] as follows:

• "[183] …[E]ven if CSA had insufficient profits to pay the dividend to CSF, a debt arose upon declaration of the dividend in November 2003 by the operation of s 254V(2) of the Corporations Act. The debt CSA then owed to CSF was a liability that was capable of enforcement by CSF. The Commissioner accepted that, as a matter of corporate law, a valid declaration by the directors that a dividend is payable would give rise to a debt owed by CSA to CSF, but contended that, in the case of CSA, there was not sufficient profits at the time of declaration and hence no dividend could be declared payable. I reject that contention.
• [184] If it was discovered that the dividend was improper because, for example, it had been declared when there were no or insufficient profits of CSA, the debt remains unless and until:
  • 1. the company issues proceedings to have the declaration of the dividend declared void: Marra Developments [
    Ltd v BW Rofe Pty Ltd [1977] 2 NSWLR 616] at 623;
    North Sydney Brick and Tile Co Ltd v Darvall (1989) 17 NSWLR 327. I reject the Commissioner's contention that Marra Developments is no longer good law because it was decided before the Company Law Review Act. Bluebottle [
    UK Ltd v Deputy Commissioner of Taxation 2007 ATC 5302; (2007) 232 CLR 598] resolved that issue: see [167] to [170] above;
  • 2. CSF disputes the validity of a declaration of dividend (because it contravenes the company's constitution and/or contravenes s 254T) and successfully obtains an injunction to restrain payment: Marra Developments at 623; or
  • 3. a creditor of the company disputes the validity of a declaration of dividend because it contravenes s 254T and successfully obtains an injunction to restrain payment: Marra Developments at 623.
• [185] In the present case, no declaratory proceedings were filed by CSA, no injunctive relief was sought by CSF or a creditor and the dividend was in fact paid (see [147] above). In my view, the Commissioner cannot rely upon the possibility of hypothetical declaratory or injunction proceedings to avoid the incurrence of a debt prescribed by statute: cf
  Cridland v Commissioner of Taxation 77 ATC 4538; (1977) 140 CLR 330 at 341."

59. The primary judge answered the second limb of the first anterior issue at Reasons [214] as follows:

"…CSA incurred a loss or outgoing of $222,655,981 when it 'declared' the dividend and, if not when it was declared, when it declared and then paid the dividend in the 2003 year."

60. On the hearing of the appeals, the Commissioner assailed the primary judge's reasoning and conclusion on the first limb of the first anterior issue, on a similar basis to his contentions below. He acknowledged the existence of, and the legal consequences provided for by s 254V(2) of the Corporations Act but contended that where, as here, the declaration of the dividend was expressly conditioned by the words that the dividend was "payable out of profits of the Company" and as s 254T of the Corporations Act provided that dividends were payable only out of the profits of the company, if CSA had insufficient profits to pay the dividend of $222,655,981 then it did not incur a loss or outgoing for tax purposes. We reject these contentions for largely the same reasons that the primary judge rejected the same contentions below. They cannot be sustained in the face of s 254V(2) of the Corporations Act.

61. But there are other reasons for rejecting the Commissioner's contentions on the first limb of the first anterior issue.

62. First, the fact that the dividend is expressed to "be declared payable out of profits" does not, in our view, mean that the validity of the declaration is conditional on there being profits to cover the dividend. That is not to say that the words of the resolution declaring the dividend could not express the existence of sufficient profit as a condition of the validity of the declaration, cf.,
Bluebottle UK Ltd v Commissioner of Taxation 2007 ATC 5302; (2006) 233 ALR 747 at [22], but that is not this case. Here, the minutes of the meeting of directors of CSA in question stated that the directors -

"had reviewed the current management accounts of the Company and believe that profits are available from which the Dividends can be paid and that the Dividends can be paid out of unappropriated profits."

And resolved, using conventional language for the declaration of dividends, that -

"the Dividends be declared payable out of the profits of the Company and that the Dividends be paid to [CSF] on 14 November 2003".

63. Given the observation that preceded the making of the declaration, the use of the words "payable out of the profits of the Company" is descriptive rather than conditional; if the belief of the directors as to the availability of profits proved to be wrong, the validity of the declaration was not in issue.

64. Second, the debt created by the declaration, even if invalidly created, was, at best, only voidable: it was not void ab initio. The consequences for the payment of such a dividend are affected by s 256D of the Corporations Act. As the Explanatory Memorandum to the Company Law Review Bill 1997 (which introduced s 254V) states:

• "11.47 If dividends are paid otherwise than out of profits, the directors may be liable for a reduction of capital in contravention of the capital reduction provisions (Bill s 256F(3), Schedule 5 Item 13 s 256D(3)). However, the Bill will validate a dividend that is not paid out of profits (Bill s 256F(2)(a), Schedule 5 Item 18 s 256D(2)(a).
• 11.48 In the case of a public company every share will have the same rights in relation to dividends, unless the company's constitution provides otherwise, or different dividend rights are provided for by special resolution (Bill s 254W(l )). For proprietary companies, the Bill will insert a replaceable rule authorising the directors to pay dividends as they see fit, subject to the terms on which the shares are on issue (Bill s 254W(2))." (Emphasis added.)

65. Section 256D provides:

• "(1) The company must not make the reduction unless it complies with s 256B(1) [which deals with reductions in capital].
• (2) If the company contravenes subsection (1):
  • (a) the contravention does not affect the validity of the reduction or of any contract or transaction connected with it ; and
  • (b) the company is not guilty of an offence.
• (3) Any person who is involved in a company's contravention of subsection (1) contravenes this subsection." (Emphasis added.)

66. Here, as the primary judge found at Reasons [184]-[185], no proceedings were instituted in 2003 by CSA, or a shareholder or a creditor of CSA, to have the dividend declared void or to enjoin CSA from making payment of the dividend, and the dividend was in fact paid.

67. It follows:

• (1) That by reason of the making of the declaration by CSA a liability came into existence, and thereafter CSA was "definitively committed and completely subjected" to paying the dividend, for the purposes of s 25-90 of the 1997 Act:
  Commissioner of Taxation v Citylink Melbourne Ltd 2006 ATC 4404(2006) 228 CLR 1 at [137]. See also
  Industrial Equity Ltd v Blackburn (1977) 137 CLR 567 at 578;
• (2) even if, as contended by the Commissioner, CSA had no profit from which it could pay a dividend, once declared, CSA was obliged to pay the dividend until and unless a Court declared the dividend void:
  Marra Developments Ltd v B W Rofe Pty Ltd [1977] 2 NSWLR 616, per Hutley JA at 623; and,
• (3) in the absence of such a declaration, the only sanctions arising from a payment of a dividend in breach of s 254T are potential offences under s 254T or s 1311 of the Corporations Act: see
  Tampalini v Robinson [2005] WASC 182 at [37]; see also
  R v Kavanagh and Williams (1998) 4 VR 581 in which the option for declaratory relief of the kind referred to in Marra Developments was endorsed.

68. But the Commissioner cannot rely on the existence of a hypothetical action not taken by any interested party to displace the taxable facts upon which the assessment must proceed:
Federal Coke Co Pty Ltd v Commissioner of Taxation 77 ATC 4255; (1977) 15 ALR 449 at 458-459,
Cridland v Commissioner of Taxation 77 ATC 4538; (1977) 140 CLR 330 at 341 and
BHP Billiton Finance Ltd v Commissioner of Taxation 2009 ATC ¶20-097(2009) 72 ATR 746 at [124], [126] and [129].

69. For the foregoing reasons, we are of the view that upon declaration of the dividend by CSA in favour of CSF, CSA incurred a debt by virtue of the operation of s 254V(2) of the Corporations Act and that was so whether or not CSA had sufficient profits out of which to pay the dividend; on such declaration, CSA incurred an outgoing for the purposes of s 25-90 of the 1997 Act.

70. Being of that view, it is not strictly necessary that we consider the second limb of the first anterior issue, namely, whether, if CSA did not incur an outgoing for the purposes of s 25-90 upon the declaration of such dividend, it did so upon payment of that dividend by endorsement of the SGTS Promissory Note in favour of CSF. Nevertheless, having regard to the comprehensive submissions made by both sides on this aspect, like the primary judge below (see Reasons [191]), it is appropriate that we deal with it.

71. At Reasons [192], the primary judge encapsulated the Commissioner's contentions on the second limb of the first anterior issue as follows:

"The Commissioner contended that there was no loss or outgoing by CSA in the 2003 year because the promissory note CSA endorsed in favour of CSF was void and unenforceable by reason of the following facts and matters:

• 1. the loss or outgoing relied upon is the endorsement of the promissory note by CSA to CSF;
• 2. the promissory note was issued (and immediately endorsed from AFC to CSA) and then from CSA to CSF in the US and expressed to be governed by Delaware law;
• 3. under Delaware law, if an unenforceable promissory note is endorsed to a third party who takes 'with knowledge' of the defect or invalidity, that third party may not enforce the promissory note;
• 4. in the present case, the promissory note was issued and endorsed by [Mr] Sutherland on behalf of SGTS, AFC, CSA and CSF when he was aware of all of the matters that resulted in the promissory note being unenforceable, namely SGTS' non-compliance with Delaware law when issuing the note combined with AFC's knowledge of that non-compliance. (The Commissioner's contention was that a consequence of an alleged non-compliance with Delaware law about the issue of dividends is that any dividend issued would violate the DGCL and be void and incapable of ratification)."

72. At Reasons [195], the primary judge said that she did not accept that the respondents had established on the balance of probabilities that SGTS had sufficient accumulated earnings to pay the dividend to AFC on 14 November 2003. Her reasons for this view are set out at Reasons [139]-[144], but principally relate to her Honour's non-acceptance of Mr Sutherland's evidence that he had made adjustments to the accounts of SGTS with the result that SGTS had sufficient accumulated earnings out of which it would pay a dividend. (Her Honour's finding that she did not accept that the respondents had established on the balance of probabilities that SGTS had sufficient accumulated earnings to pay the dividend to AFC on 14 November 2003 was not initially challenged by the respondents on the hearing of the appeals, but on the second day the respondents sought leave to file a notice of contention out of time going to this issue. After considering written submissions from the parties on the question of whether leave should be granted, the Court declined to grant leave for the reasons set out at [86]-[92] below.)

73. At Reasons [208]-[211], the primary judge said that although she did not accept that the respondents had established that SGTS had sufficient accumulated earnings to pay the dividend to AFC in 2003, it did not follow that the dividend (and the promissory note) were invalid. In this regard, her Honour referred to and relied on the unchallenged evidence of Mr Balotti that a dividend paid in contravention of a restriction would not be void, referring to s 174 of the DGCL. Relevantly, at [211], her Honour said:

"The premise underpinning the remedies was that a 'dividend' continued to exist even though it had been paid in contravention of the DGCL. Here, no action against the directors was taken. The dividend was declared and paid."

74. At Reasons [212] the primary judge referred to the Dividend Distribution Agreement whereunder SGTS and AFC agreed to accept the SGTS Promissory Note as payment of the dividend and observed that absent rights as a creditor, it was not open to the Commissioner to interfere with what they agreed. At Reasons [213] her Honour said:

"In the end, I accept that it is the promissory note issued under and in accordance with the terms of the Dividend Distribution Agreement which armed AFC with 'funds' to pay the dividends to CSA. The rights the Dividend Distribution Agreement gives AFC for payment are not able to be impugned by the Commissioner. They might have been able to be impugned by action under s 174 of the DGCL, but they were not. There was no proceeding to suggest, let alone establish, that the dividend was paid in contravention of the DGCL:
Federal Coke Company Pty Ltd v Federal Commissioner of Taxation 77 ATC 4255; (1977) 15 ALR 449 at 458-459, Cridland at 341 and
BHP Billiton Finance Ltd v Commissioner of Taxation 2009 ATC ¶20-097; (2009) 72 ATR 746 at [124], [126] and [129]. The fact remains that the promissory note was not cancelled and indeed was honoured by a wire transfer of cash on 24 November 2003."

75. On the hearing of the appeals, the primary judge's process of reasoning, outlined in [72]-[74] above, was assailed by the Commissioner on a number of fronts as detailed in [76] below.

76. According to the Commissioner:

• (1) "The primary judge found that SGTS did not have sufficient accumulated earnings to declare the dividend of $222,655,981 and the declaration of the dividend was contrary to Delaware law."

  Reference is given to Reasons [144], [164], [195] and [229(7)] as support for this alleged finding. The primary judge made no such finding. The primary judge, at each of the references referred to, found that SGTS did not have sufficient accumulated earnings to pay the dividend; not insufficient accumulated earnings to declare the dividend, and her Honour did not find that the declaration was contrary to Delaware law. At most, her Honour found that the dividend had been paid in contravention of the DGCL, but even if it was, absent proceedings under s 174 of the DGCL, the dividend was not invalid: (Reasons [164], [211] and [213]).

• (2) "There was uncontradicted and unchallenged evidence from Mr Tumas that if the dividend was contrary to Delaware law, then it followed that a promissory note used to pay that dividend would be unenforceable in the hands of a recipient with knowledge of the defect."

  Reference is given to Mr Tumas' first report dated 17 May 2010 and his answer to question 1(b) at pp 19-25 of that report. But everything Mr Tumas said in this part of his first report concerning the unenforceability of the promissory note is predicated on the dividend being invalid. The primary judge concluded, correctly in our view, that whilst the dividend may have been paid in contravention of the DGCL, it did not follow that the dividend was invalid: (Reasons [164], [208]). Indeed, as the primary judge observed at Reasons [209], Mr Balotti gave unchallenged evidence that a dividend paid in contravention of a restriction would not be void.

• (3) "[T]he promissory note was unenforceable in the hands of AFC, CSA and CSF."

  The sole basis of this submission is Mr Tumas' first report and is predicated on the dividend being invalid (see (2) above). The primary judge, correctly in our view, found that it was not invalid and in the face of that finding, the submission of unenforceability cannot be sustained.

• (4) "In the absence of an enforceable promissory note, CSA did not have sufficient profits to pay the CSA dividend."

  Again, the submission fails for want of the correctness of the premise upon which it is predicated.

77. It follows, in our view, that if it matters, and in our view it does not (see [69] above), if CSA did not incur an outgoing of $222,655,981 when it declared the dividend, it did so when it declared and paid the dividend by the endorsement of the SGTS Promissory Note to CSF.

Second anterior issue - Whether outgoing incurred in deriving income from a foreign source

78. This issue was only addressed by the primary judge in the context of her Honour's first conclusion; it was not addressed in the context of her alternative conclusion. In view of our conclusion at [54] above, the issue is irrelevant to her Honour's alternative conclusion.

79. In relation to this issue, the primary judge found that s 25-90 adopts similar language to s 8-1 and does not require "matching" of outgoings and income: (Reasons [220]). Her Honour also found that Parliament did not intend s 25-90 to include a deduction for losses or outgoings incurred in deriving an amount that was of a capital nature: (Reasons [221]). The Commissioner did not take issue with these findings and, as indicated at [43] above, accepted that to the extent any income was derived, it was from a foreign source: (Reasons [230]).

80. The primary judge's process of reasoning on this second anterior issue, including her Honour's responses to the submissions that were put to her by the parties may be summarised as follows:

• (1) At Reasons [223] her Honour referred to the respondents' reliance upon the payment of the dividends from SGTS to AFC as the derivation of income from a foreign source and the Commissioner's submission that a return of capital invested is not income and that when SGTS purported to pay dividends of $222,655,981 on 14 November 2003, that payment was necessarily a return of capital because it was not a payment from distributable profits.
• (2) At Reasons [224]-[226], her Honour said that the issue of whether the payment by SGTS was income therefore requires identification of the share capital of SGTS and the distributable profits of SGTS at 14 November 2003. Her Honour observed that both Mr Balotti (the respondents' expert) and Mr Tumas (the Commissioner's expert) agreed that under Delaware law (SGTS was a Delaware company), the SGTS Preferred Stock issued capital was US$489.32 (each share having a par value of US$0.52) and not US$1 billion, being the price paid for the preferred stock. Mr Sutherland's evidence was to the same effect. In consequence, her Honour rejected the Commissioner's contention that SGTS' share capital included the US$1 billion.
• (3) At Reasons [227] her Honour repeated an earlier observation (see [79] above) that it is not necessary for a taxpayer to actually derive a dividend to which s 23AJ of the 1936 Act applies in the same year as that in which the cost is incurred. Her Honour found:

  "It could not seriously be doubted that AFC did … [see T58-9] expect to receive dividend income in the five years from 2001 to 2006. AFC owned all of the common stock and the preferred stock in SGTS. SGTS had acquired rights to the royalty streams (valued at US$4 billion) as well as other assets. SGTS' principal liabilities constituted only a loan of US$3 billion. The purpose of the structure was to ensure the tax neutrality of the Project Gemini dividend flow into and out of Australia: see [28] above. The fact that a dividend would be paid in that period constitutes a more than sufficient nexus with the gaining of income from a foreign source: cf
  Spassked Pty Ltd v Federal Commissioner of Taxation (2003) 136 FCR 441 at 464 and
  Federal Commissioner of Taxation v Total Holdings (Australia) Pty Ltd (1979) 43 FLR 217. Finally, the expectation about the derivation of income is considered at the time the redeemable preference shares are subscribed for, not the time CSA declared the dividend: Spassked at 464 and Total Holdings."

• (4) In the light of those findings, her Honour concluded at Reasons [228] that it was unnecessary to resolve the question about the nature of the payment from SGTS to AFC in November 2003 and, in particular, whether the payment was in the nature of income or a return of capital; the loss or outgoing was incurred at the very least when there was an expectation that a valid s 23AJ dividend would be paid by SGTS on or after 30 November 2003 but before the redemption of shares in 2005.
• (5) Further, in the light of earlier findings, at Reasons [229] her Honour found it unnecessary to revisit the Commissioner's contention that the receipt of a promissory note did not amount to the derivation of income because the note was unenforceable in the hands of AFC/Noza.

81. On the hearing of the appeals, the Commissioner assailed the primary judge's findings in respect of, and conclusion on, the second anterior issue, on a number of bases. According to the Commissioner:

• "(1) '[T]he promissory note was unenforceable…nothing was derived by Noza, and therefore no "income" was derived as a result of the SGTS dividend of 14 November 2003.'

  For the reasons given in [76] above, we reject the premise upon which this submission is made, namely, that the dividend was invalid and therefore the promissory note was unenforceable.

• (2) '[T]he [primary] judge effectively reversed the onus of proof concerning the income or capital nature of the dividend…the Commissioner was not obliged to establish that the receipt was in the nature of a return on shareholders' capital.'

  We totally reject this submission. There is nothing in the Reasons to suggest that the primary judge placed some onus of proof on the Commissioner. The primary judge found that, under Delaware law, the dividend from SGTS to AFC did not involve a return of capital; it was therefore income. It has to be one or the other because they cover the field.

• (3) 'In the case where the potential income in question is a distribution from a company, then for it to be income according to ordinary concepts the distribution must be one of company profits as opposed to a distribution of amounts contributed by the shareholders, see paras [218]-[221] of the Reasons. Using the language used in
  Eisner v Macomber, which was quoted by the trial judge and which has been accepted by the High Court, for a receipt to be income from a shareholding, it must be "a gain, a profit, something of exchangeable value, proceeding from the company, severed from the capital, however invested or employed"; this must be ascertained from the viewpoint of the (Australian) shareholder. In the case of a distribution from a company, only a distribution of profits satisfies this description. Otherwise what is being distributed is not severed from the capital contributed by the shareholders and employed by the company.'

  As noted in [44] above, the word 'income' in para (a) of s 25-90 is a reference to income at general law and is not concerned with whether a company distribution is assessable income by virtue of s 44(1) of the 1936 Act. So understood, the point of distinction is to emphasise that the outgoing must be incurred in deriving income, not capital. When one is concerned with whether an item is income or capital at general law, one is concerned with its quality in the hands of the recipient (McNeil at [20]), not with the source of the fund or account out of which the corporate distribution is paid, cf., s 44(1). A gain derived from property has the character of income, particularly where the property producing the gain remains intact: McNeil at [21] and [22]. Here, the preference stock that AFC held in SGTS remained intact following the declaration and payment of the dividend and the dividend was undoubtedly the product of that stock. From the point of view of AFC it was, under the principles enunciated in McNeil, income at general law in its hands, even if it was not assessable income under s 44(1) of the 1936 Act because the source of the distribution was not 'accumulated earnings' of SGTS.

  On the other hand, even when viewed from the perspective of SGTS, a Delaware company, it was, as the primary judge found at Reasons [226], not a distribution or return of capital. Both experts agreed that the capital of SGTS would equal (i) US$489.32 (representing the aggregate par value of the issued shares of SGTS Preferred Stock) plus (ii) the amount equal to the aggregate par value of the issued shares of common stock of SGTS. The balance of the US$1 billion paid by AFC for the shares of SGTS Preferred Stock would, according to both experts, fall into and form part of SGTS' 'surplus' out of which dividends may be paid, although both agreed that the use of the term 'accumulated earnings' in the Certificate of Designation imposed an additional restriction on SGTS' ability to pay dividends. However, the point of these observations is that the distribution made on 14 November 2003 by SGTS to AFC (Noza), while paid contrary to the restriction of the Certificate of Designation in the absence of a finding of there being sufficient 'accumulated earnings', was paid out of 'surplus' and was not a return of capital. The 'surplus', free of the restriction of the Certificate of Designation, was as much a profit account out of which dividends could be paid as the 'accumulated earnings' account. That is not surprising; indeed, in this country, prior to s 60 of the Companies Act 1961 (NSW) (subsequently s 119 of the Companies Code), there was no statutory prohibition preventing the distribution of premiums, that is, amounts received on the issue of shares over and above the par value of the shares, as dividends:
  Drown v Gaumont-British Picture Corporation Ltd [1937] Ch 402 at 403 per Clauson J;
  Re Application of The News Corp Ltd (1987) 15 FCR 227 at 234 per Bowen CJ.

• (4) 'The Commissioner submits that the [primary] judge was incorrect in holding that the correct time for the expectation [as to the derivation of income] to be tested (apparently once and for all) was at the time of subscribing for the SGTS Preferred Stock. The correct position is that the expectation must be tested on an outgoing by outgoing basis based on the facts prevailing in each tax year.'

  This is a reference to her Honour's finding in the last sentence of Reasons [227]. Insofar as it is submitted that her Honour's finding was on a once and for all basis, we reject the submission. There is no doubt that the appropriate time to first look at the expectation is at the time of acquisition of the income producing asset. At that time, the primary judge found that:

  "It could not seriously be doubted that AFC did expect to receive dividend income in the five years from 2001 to 2006."

  On the hearing of the appeals, that finding was not challenged. What was challenged was the primary judge's statement that the Commissioner conceded that a valid s 23AJ dividend would have been paid by SGTS on or after 30 November 2003 but before the redemption of shares in 2005. That was challenged because it was said to be made in collateral proceedings involving reliance on the general anti-avoidance provisions of Pt IVA between different parties to the present appeals.

  Whether that be right or not, the primary judge's finding as to expectation at the date of acquisition of the SGTS Preferred Stock was not challenged. Neither did the Commissioner point to any change in circumstances from year to year, or, in particular, as at 14 November 2003, which would warrant a review by the primary judge, or this Court on appeal making a finding that ACF's (Noza's) expectation at the time of acquisition of the preferred stock was no longer extant.

  "

82. For these reasons, there was no error in the primary judge's conclusion that the second anterior issue was also satisfied. It follows, having regard to the Commissioner's concession referred to in [56] above, that Noza is entitled to a deduction under s 25-90 in the 2003 income year, but that the amount of that deduction is limited, for the reasons there given, to $170,983,354.

The respondents' proposed notice of contention

83. As noted in [72] above, the primary judge's finding that she did not accept that the respondents had established on the balance of probabilities that SGTS had sufficient accumulated earnings to pay the dividend to AFC on 14 November 2003 was not initially challenged by the respondents on the hearing of the appeals; however, on the second day the respondents sought leave to file a notice of contention out of time going to this issue. The respondents' application for leave was opposed by the Commissioner.

84. The proposed notice of contention provided, inter alia -

"The Respondent contends that the judgment of the Federal Court should be affirmed on grounds other than those relied on by the Court.

The Respondent does not seek to cross-appeal from any part of the judgment.

Grounds relied on

The Respondent will contend that based on the evidence:

• a) at tab 5 Appeal Book Part C;
• b) of Mr Balotti that the preferred stock issued by Solutions Group Transaction Subsidiary Inc to ITW AFC Pty Ltd was clearly 'equity';
• c) of Ms Mills that 'if an instrument denominated in a foreign currency is considered part of stockholders' equity, changes in foreign exchange rates are irrelevant, as changes in exchange rates do not give rise to any accounting differences to be recorded';

that Solutions Group Transaction Subsidiary Inc had sufficient accumulated earnings [to pay] the dividend on the preferred stock on 14 November 2003."

85. The reference to "tab 5 Appeal Book Part C" is a reference to SGTS' financial reports for the years ended 30 December 2001, 2002, 2003, 2004 and 2005 prepared in accordance with US GAAP (the Hyperion financials), of which extracts depicting the net income of each of the 2001-2004 years is set out at Reasons [151], and at [40] above.

86. Essentially, what the Court is being asked to do, belatedly, is make a finding of fact that SGTS had sufficient "accumulated earnings" to pay the dividend on the preferred stock on 14 November 2003, notwithstanding that the primary judge did not accept that Mr Sutherland had in fact made the adjustments which he deposed to making (see Reasons [140]), which included those in paras (b) and (c) of the proposed notice of contention, or that the respondents had established on the balance of probabilities that SGTS had sufficient accumulated earnings to pay the dividend to AFC on 14 November 2003. In other words, despite the primary judge's non-acceptance of those matters, the Court is being asked, on the evidence referred to in the proposed notice of contention, to make notional adjustments the subject of that evidence and, in the light of those notional adjustments, to make the relevant finding of fact.

87. It seems fairly clear that the primary judge was not asked to do this otherwise her Honour's description and characterisation of the respondents' submission at Reasons [161] would have embraced it; they did not. They merely referred to the adjustments alleged to have been made by Mr Sutherland which her Honour did not accept. In this sense, the finding of fact which the Court would be asked to make would be new; the point was not run below.

88. In our view, it would not be open to this Court to make any such notional adjustments as a precursor to such a finding of fact without the benefit of expert evidence that such a reading of SGTS' GAAP accounts unadjusted was a permissible reading of those accounts and that such a reading led to the conclusion of fact. The Commissioner submitted, and we accept, that had the respondents run the point below, the Commissioner is likely to have adduced additional evidence from Mr Tumas and also to have asked additional questions in cross-examination of Mr Balotti.

89. As Gleeson CJ said in
Whisprun Pty Ltd v Dixon (2003) 200 ALR 447 at [51]:

"It would be inimical to the due administration of justice if, on appeal, a party could raise a point that was not taken at the trial unless it could not possibly have been met by further evidence at the trial."

90. Additionally, there are the more general considerations which Jessup J considered in
Aurpeerapatthana v Minister for Immigration & Citizenship [2011] FCA 887 at [15] touching on the proper role of an appeal court. This approach has added force where, as here, the parties were well resourced and well represented.

91. In their written submissions on this issue, the respondents referred to the decision of Kenny and Middleton JJ in
Commissioner of Taxation v American Express Wholesale Currency Service Pty Ltd (2010) 187 FCR 398, but that case seems to have been in the category of a pure question of law which may, at least generally, be raised for the first time on appeal.

92. For the foregoing reasons, the Court refused the respondents' leave to file and rely on the proposed notice of contention.

Proposed orders

93. The Commissioner's appeals in respect of AFC for the 2002 income year (VID 201/2011) and in respect of Noza for the 2004 and 2005 income years (VID 197/2011 and VID 200/2011) should be allowed. The appeal in respect of Noza for the 2003 income year (VID 198/2011) should be dismissed. Two of the appeals, VID 196/2011 for the 2004 income year and VID 195/2011 for the 2005 income year, concerned disallowance of carry- forward losses, presumably from the 2003 income year. The Court was not provided with sufficient material to enable it to dispose of these latter appeals. In the circumstances, the appropriate order in respect of all appeals is that the parties bring in short minutes of order to give effect to these reasons in respect of all appeals.

94. On the issue of costs, both parties have had a measure of success. Noza has succeeded in relation to the 2003 income year (a deduction of $170,983,354) and the Commissioner has succeeded in relation to the 2002, 2004 and 2005 income years (disallowance of deductions of $83,001,628.53 in each year - 2002 (AFC) and 2004 and 2005 (Noza)). In the circumstances, we presently incline to the view that each of the Commissioner and the respondents should pay their own costs of the appeals. We will, nevertheless, give the parties seven days in which to make written submissions on the issue.

95. This leaves the issue of costs before the primary judge. Her Honour ordered the Commissioner to pay 80% of the present respondents' costs in each proceeding. The primary judge was undoubtedly mindful that before her Honour, the respondents were largely successful, save for a reduction in the deductions claimed to properly reflect the amount which was a cost in relation to a debt interest to which para 25-90(d) applied (see [56] above). On the other hand, the respondents were totally successful in relation to the Commissioner's reliance on Pt IVA, which obviously occupied a large part of the case run below, but which the Commissioner abandoned shortly after lodging his notices of appeal to this Court. Taking these matters into consideration, as well as the matters referred to in [94] above, we presently incline to the view that the costs orders below should be set aside and the Commissioner be ordered to pay a lesser percentage of the applicants' costs before the primary judge, but again we will give the parties seven days in which to make written submissions on the issue.