Decision impact statement
Commissioner of Taxation v BHP Billiton Finance Limited; Commissioner of Taxation v BHP Billiton Limited
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Court Citation(s):
Federal Court
[2010] FCAFC 25
(2010) 182 FCR 526
(2010) 76 ATR 472
2010 ATC 20-169
High Court
[2011] HCA 17
(2011) 277 ALR 224
2011 ATC 20-264
79 ATR 1
Venue: Federal Court of Australia
Venue Reference No: VID 270, 271, 274, 289 & 290 of 2009 (FC); M117-M125 of 2010 (HC)
Judge Name: Sundberg, Stone and Edmonds JJ (FC); French CJ, Gummow, Heydon, Crennan and Bell JJ
Judgment date: 17 March 2010 (FC); 1 June 2011 (HC)
Appeals on foot: No.
Special leave on the application of Part IVA was refused by the High Court
Decision Outcome: Adverse (FC); Adverse (HC)
Impacted Advice
Relevant Rulings/Determinations:
Subject References:
Bad debt claims
Business of lending money
Ordinary course of your business of lending money
Part IVA
Giving effect to a Part IVA determination
Tax benefit
Limited Recourse Debt
Debt Property
Capable of being limited
Précis
Whether bad debt deductions are allowable for loans made by an in-house finance company and whether debt funding from the finance company to a special purpose group subsidiary was limited recourse debt so capital allowances could be adjusted.
Brief summary of facts
The taxpayers are members of the BHP Billiton Ltd ( BHPB ) group of companies. BHP Billiton Finance Ltd ( Finance ) is the internal financier of the BHPB group. It raised large sums of money from external financial institutions and lent amounts rolled over every 5 months to other BHPB group companies. Finance based its lending decisions on the BHPB board approval of capital expenditure on the group's projects. Finance did not have its own staff and instead utilised the services of BHPB for which it paid management fees. The interest rate charged on loans from Finance to BHPB group companies was higher than the interest rate at which it borrowed those funds. As a result, it earned substantial interest income and generated substantial taxable income.
HBI project and BHPDRI
In June 1995, the BHPB board approved capital expenditure of $1,550 million for the design, construction and commissioning costs of a Hot Briquetted Iron ( HBI ) project at Port Hedland, WA. BHPB established a wholly owned subsidiary, BHP Billiton Direct Reduced Iron Pty Ltd ( BHPDRI ), to own the HBI plant itself. Whilst a positive net present value ( NPV ) was recorded in the capital expenditures submission for the project as a whole (evaluated on an ungeared basis in accordance with a Capital Procedures Manual), a large negative NPV recorded for BHPDRI was attributable to the fact that a large part of the cashflow to be generated by the project would flow to group entities other than BHPDRI. It financed its expenditure on the HBI plant from shareholder funds contributed by another BHPB subsidiary (BHPB Minerals Holdings Pty Ltd) and by borrowing money from Finance. Finance provided loans to BHPDRI at the direction of BHPB. Under Finance's standard loan terms, the loan to BHPDRI was limited to a term of 5 months, but was renewed at the expiry of each 5 month term. Finance enjoyed all the rights of an unsecured creditor.
The costs of the HBI project exceeded the initial capital expenditure approval and on 29 November 1996, the BHPB board approved additional capital expenditure of $123.6 million that was again funded by shareholder funds and by borrowing from Finance. In August 1997, a review of the HBI project was conducted and a decision was made to continue the project. The BHPB board approved further capital expenditure of $730 million. Further loans were made by Finance to BHPDRI. On 31 May 1998, the carrying value of BHPDRI's non-current assets was written down by $590 million. After a further review in November 1998, a decision was made to continue the HBI project to a testing phase. On 30 June 1999, the carrying value of BHPDRI's non-current assets was written down by a further $531 million. On 20 July 1999, the directors of BHPDRI were provided with an undertaking that BHPB would provide sufficient funds to pay company debt if BHPDRI was called upon to pay those debts. The undertaking did not include the debts owed by BHPDRI to Finance. Finance subsequently confirmed that it did not intend to seek repayment of the loan to BHPDRI for a period of 12 months. Additional capital expenditure was approved on 23 March 2000, to enable trials to be carried out.
On 30 March 2000, the BHPB board resolved to engage Ernst & Young to review the carrying value of the loan to BHPDRI. Pending that report, Finance made provision for a doubtful debt in respect of the loan of $2,174 million. This left Finance with negative net assets and BHPB injected $950 million by subscribing for shares in Finance. Ernst & Young provided its valuation report on 3 May 2000, valuing Finance's loan to BHPDRI at $364 million. On the basis of the Ernst & Young report and without issuing a demand for payment, the directors of Finance resolved on 3 May 2000 that an amount of $1,845,833,281 (being the difference between the loan balance of $2,191,833,281 at that date and the Ernst & Young valuation) was irrecoverable and should be written off as bad. The amount of $1,845,833,281 was written off in the books of Finance on 3 May 2000 and the directors of BHPDRI were informed in a letter dated 10 May 2000. The balance of $346 million continued to be accounted for as a doubtful debt and all parties understood they were compromising the debt. Finance claimed the $1,845 million write-off as a bad debt deduction in its return for the year ended 30 June 2000. The BHPB group also applied the Commercial Debt Forgiveness provisions in Division 245 of Schedule 2C of the ITAA 1936 to adjust BHPB's tax attributes that existed within the group at the time of the write-off.
The HBI project continued until 2004, when BHPB terminated the project following an explosion at the plant.
In the 2000, 2001 and 2002 years capital allowance deductions were claimed by BHPDRI (resulting losses were transferred out to other BHPB group entities in the 2001 and 2002 years). In the 2003, 2004, 2005 and 2006 years the deductions were claimed by BHPB as head entity of the consolidated group.
The Commissioner disallowed the $1,845 million bad debt deduction claimed by Finance and made adjustments to capital allowance deductions in respect of the assets of BHPDRI on the basis that the loan by Finance to BHPDRI was limited recourse debt pursuant to Division 243 of the ITAA 1997.
Beenup Project and BHPTM
On 15 November 1994, approval from the BHPB board was sought for capital expenditure of $222.6 million for the purpose of developing mining and processing facilities at Beenup, WA and the purchase of an interest in an existing smelting facility in Norway. The mine and associated processing facilities were to be conducted by BHP Titanium Minerals Pty Ltd (BHPTM). The capital expenditure submission recorded the nominal internal rate of return of the proposal as 19.1% (15.2% real) with a payback period of 6.7 years. The BHPB board approved the submission on 24 November 1994. A loan facility was established for BHPTM in accordance with Finance's standard terms.
On 5 July 1995, a two year letter of comfort was provided by BHPB to the directors of BHPTM in which BHPB undertook to ensure that BHPTM was provided with sufficient funds to pay existing and future debts. A second letter of comfort was provided on 17 July 1997 on essentially the same terms as the first, other than it was to apply for one year. A third letter of comfort was provided on 9 July 1998.
The loan funds provided by Finance were used to fund the continuing development of the Beenup mine from 1995. Production at the mine commenced on 13 January 1997. By late 1997, the mine had experienced significant operational difficulties. These difficulties continued to affect the mine and, in February 1999, a decision was made to close the plant and write off the balance of the carrying value of the investment. Operations at the plant ceased on 16 April 1999. After the mine closed, BHPTM conducted a review of options available and considered the means by which it could service its loan with Finance. On 31 May 1999, Finance provided approximately $62 million to BHPTM to enable it to repay an overdraft it had with the ANZ bank.
On 8 July 1999, a fourth letter of comfort was provided. It was in the same terms as the previous letters except it also stated that it was "not intended to impose any contractual or legal obligations on [BHPB] in respect of any other person nor bind it to any particular requirement or course of action".
BHPTM completed its review of options in early August 1999. Following a meeting of directors on 18 August 1999, BHPTM wrote to Finance stating inter alia that "the prospects of expanding the company's activities to assist with the servicing and repayment of its debt to [Finance] are now, in all likelihood, non-existent".
In accordance with actions recommended in a BHPB memorandum dated 20 August 1999, to write down the majority of the loan to BHPTM, the following steps were taken on 23 August 1999:
1. BHPB wrote to BHPTM stating that the Letter of Comfort was to be revoked and proposed entry into a limited Deed of Support.
2. At 11.15 am, the Directors of BHPTM met and resolved to enter into the Deed of Support, which was said to provide the directors of BHPTM with greater security, as it would be legally enforceable, but limited BHPB support to BHPTM's external debt only.
3. At 12 noon the directors of Finance met and resolved to call for payment of the BHPTM loan of $339,216,146.22 set off against the deposit of $11,593,237.88 and, in the event that there was a failure to repay the balance, to write off as bad the balance outstanding of $310,881,702.40.
4. A letter was sent by Finance to BHPTM advising that the loan facility had been cancelled and demanding immediate payment of the amount outstanding.
5. BHPTM subsequently informed Finance that it could not pay.
6. Finance told BHPTM of the write-off and the set off against the amount on deposit.
7. The directors of BHPTM resolved to record both the write-off and the set off in the accounts of BHPTM.
Finance claimed a $310.8 million deduction for the bad debt in the year ended 30 June 2000. The Commissioner disallowed the deduction and in the alternative applied Part IVA to cancel the deduction.
Issues decided by the court
Full Federal Court - Bad Debt Deductions
The bad debt deduction issues before the Full Federal Court were as follows:
1. Whether Finance was entitled to deductions of:
- (a)
- $1,845,833,281 for the loan to BHPDRI written off as bad in the 2000 year of income; and
- (b)
- $310,881,703 for the loan to BHPTM also written off as bad in the 2000 year of income;
- pursuant to s 25-35(1) (b) of the ITAA 1997. The central question in that case was whether Finance was in the business of lending money and, if so, whether each loan was made by Finance in the ordinary course of that business.
2. Alternatively, whether Finance was entitled to a deduction in respect of each amount written off as bad pursuant to s 8-1 of the ITAA 1997. The central question in that case is whether the amounts written off were losses of capital, or of a capital nature.
3. If Finance was entitled to a deduction in relation to the loan to BHPTM written off as bad, whether:
- (a)
- the Commissioner was entitled to rely on s 163A(3) of the ITAA 1936 in making a determination under s 177F(1)(b); and
- (b)
- if so, whether Part IVA applied to cancel the bad debt deduction claimed by Finance in respect of the loan to BHPTM.
- Edmonds J, with whom Sundberg and Stone JJ agreed, held that the loans written off as bad were allowable deductions to Finance and that Part IVA did not apply.
1. Deductibility of bad debts under s 25-35(1)(b)
At first instance, the primary judge noted that the Commissioner conceded that the evidence established that Finance borrowed monies from third parties at commercial rates of interest, it on lent those monies to related entities at a higher rate of interest to fund group operational activities and new projects, and in so doing it earned substantial profit. Edmonds J rejected the Commissioner's submission that this alone did not establish that Finance was in the business of lending money and that what was required was an analysis by Finance of the risks in making the specific loans that it made. His Honour did not find anything in the relevant authorities to support this submission and held in the face of the undisputed evidence that Finance was carrying on a business of lending.
Edmonds J also held that the loans to BHPDRI and BHPTM were made in the ordinary course of that business. According to his Honour, what is in the ordinary course of Finance's business is to be determined by reference to the context in which Finance carries on that business, not by reference to the way in which a major banking organisation might do so.
Contrary to the submissions advanced by the Commissioner that Finance had not discharged its onus and the loans were not in the ordinary course of a business of lending because they were made at the behest of BHPB and were no more than the means selected for providing funds for capital investment, his Honour found that Finance established what was the ordinary course of its business and that the loans in issue were consistent with the ordinary course of that business. Accordingly, his Honour noted in this context that:
- •
- the loans were made to BHPB group entities to fund projects and operations approved by the BHPB board;
- •
- the loans were made in accordance with the standard terms for inter-company loans;
- •
- the loans were recorded in the books and records of Finance in the same way as other intra-group loans; and
- •
- the loans were made using a practice and procedure consistent with other loans that had generated large profits for Finance.
2. Deductibility under s 8-1
In view of the above findings, Edmonds J held that the write-off of the debts as bad were losses incurred in carrying on a business for the purposes of gaining or producing assessable income. As they were not losses of capital, or of a capital nature, they were, alternatively, allowable deductions under s 8-1.
3. Part IVA
Edmonds J held that the Commissioner was entitled to rely upon s 169A (3) of the ITAA 1936 in making the determination under s 177F (1) (b). Consequently, it was not necessary to issue an assessment to give effect to a Part IVA determination where there was no change to taxable income or tax payable and the Part IVA determination is made in the course of considering an objection.
However, his Honour held that Part IVA did not apply to otherwise disallow the allowable deduction in respect of the amount of the BHPTM loan written off as bad pursuant to s 25-35(1) (b). His Honour agreed with the finding of the primary judge that because the debt was 'conjecturally bad' before the revocation of a letter of comfort dated 8 July 1999, Finance did not obtain a tax benefit by reason of the scheme identified by the Commissioner (which included revocation of the letter of comfort and replacing it with a limited Deed of Support).
His Honour went on to observe that the matters in s 177D(b) which regard must be had to did not point to a sole or dominant purpose of obtaining the bad debt deduction because the writing off of the loan to BHPTM was the most obvious and simple commercial solution.
French CJ, Crennan and Bell JJ refused the Commissioner special leave to appeal from the decision of the Full Federal Court in relation to the Part IVA issue.
High Court - Limited Recourse Debt
The issue before the High Court was whether Division 243 of the ITAA 1997 applies to adjust capital allowance deductions claimed by BHPB as head entity of a tax consolidated group in respect of assets of BHPDRI. The central question was whether the BHPDRI loan was limited recourse debt pursuant to s 243-20(2).
Under s 243-20(1) limited recourse debt exits where the rights of the creditor as against the debtor in the event of default in payment of the debt are limited wholly or predominantly to the property financed by the debt (the debt property). A debt is also a limited recourse debt if, having regard to certain circumstances, it is reasonable to conclude that the creditor's rights in the event of default are capable of being limited in that way: s 243-20(2).
In a joint judgement French CJ, Heydon, Crennan and Bell JJ accepted as correct the Full Federal Court's construction of s 243-20 - that it is '...confined to situations where, at the time of borrowing, the debtor is not fully at risk in relation to expenditure because of contractual limitations on the lender's rights of recourse on a relevant event of default (s 243-20(1)) or where, at the time of borrowing, the debtor, or someone else, has the capacity to bring about that state of affairs subsequently (s 243-20(2))' [36]. Insofar as s 243-20(1) is concerned the Commissioner accepted that construction.
Their Honours referred to the Explanatory Memorandum to the Bill which introduced the limited recourse debt provisions, and they referred, in particular, to an example that was given of the mischief that occurs ' where the balance of an outstanding debt that has financed the expenditure is not paid and the financier can only recover a specific asset on the termination of the financial arrangement'. They also referred to the statement in the EM that 'a debt is also limited recourse if, notwithstanding that there may be no specific conditions to that effect, it is reasonable to conclude that the creditor's rights against the debtor are able to be limited, directly or indirectly, to those property rights specified ... in relation to the financed property'. [46]. They then said that, 'while such statements illuminate, they do not overcome the need to consider the words of the section' [47].
The High Court rejected the Commissioner's submission that s 243-20(2) is concerned with a practical capacity or ability to bring about limitations on legal rights. In particular, their Honours held that capable of being limited is a reference to a power of a person to limit or bring about a limitation of a creditor's rights of recourse and that such a power must exist at the inception of the loan [53]. Hence, the existence at the inception of the loan of a possibility of a person acquiring a capacity to limit the creditor's rights of recourse would be insufficient. Otherwise, according to their Honours at [54], all loans used by a debtor to acquire property, including through special purpose entities, would be limited recourse debt within s 243-20(2) (echoing the concerns raised by Edmonds J in the Full Federal Court below).
According to their Honours at [55] such an interpretation of s 243-20(2) '...aligns closely with the language of the Act, which supports the clear legislative purpose of allowing an adjustment of the taxpayer's income if the taxpayer has not been fully at risk in respect of an amount of expenditure.' Moreover, it excludes the conjectural approach which otherwise would arise were the Commissioner's contentions correct and enables taxpayers to determine whether a debt is commercial debt (for the purposes of the commercial debt forgiveness provisions), or limited recourse debt.
The Commissioner argued that the rights of Finance as against BHPDRI were capable of being so limited, having regard to the fact that:
1. BHPDRI's assets were overwhelmingly comprised of the debt property: s 243-20(2)(a) and (c); and
2. Finance and BHPDRI were not dealing with each other at arm's length: s 243-20(2) (d).
Having regard to the construction of s 243-20(2) (i.e. that it does not concern possibilities for a limitation of a creditor's rights) it was not necessary for their Honours to consider the particular factual circumstances raised by the Commissioner.
In a separate judgment Gummow J came to similar conclusions to those reached by their Honours in the joint judgment. His Honour also rejected the Commissioner's assertion that the parties were not dealing with each other at arm's length.
ATO view of Decision
The ATO did not seek special leave to appeal from the decision of the Full Federal Court in relation to the bad debt deductions, save for the application of Part IVA to the writing off of the loan by Finance to BHPTM.
The bad debt case turns on its own facts and the findings made by the Federal Court. The ATO accepts the view that what is or is not in the ordinary course of a taxpayer's business of lending money must be determined by reference to the context in which that business was carried on by the taxpayer.
In addition, it is well settled that the application of Part IVA will be sensitive to the facts of each case and the Commissioner will take all decisions of the High Court and Federal Court into account in applying Part IVA to the particular facts of cases.
In relation to the application of Division 243, the legislation is directed at a debtor taxpayer who has not been fully at risk in relation to an amount of expenditure. However, the words 'capable of being limited' are a reference to a power of a person to limit or bring about a limitation of a creditor's rights of recourse and such a power must exist at the inception of the loan.
It is noted that the tax consolidation company group provisions disregard transactions, including loans, between entities within the company group. Although the case is in respect of related party financing prior to the introduction of the tax consolidation company group regime, the policy implications of the decision on post tax consolidation choices by both domestic and foreign based groups are being examined in relation to bad debt deductions and limited recourse debt.
Administrative Treatment
Implications for ATO precedential documents (Public Rulings & Determinations etc)
None.
Implications for Law Administration Practice Statements
None.
Legislative References:
Income Tax Assessment Act 1997
25-35
8-1
Division 243
Income Tax Assessment Act 1936
Part IVA
Schedule 2C, Division 245
Case References:
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[2009] 25 VR 411
[2009] VSCA 238
AVCO Financial Services Ltd v Federal Commissioner of Taxation
(1982) 150 CLR 510
13 ATR 63
82 ATC 4246
Canwest Global Communications Corporation v Australian Broadcasting Authority
(1998) 82 FCR 46
153 ALR 47
Charterbridge Corporation Ltd v Lloyds Bank Ltd
[1970] Ch 62
CIC Insurance Ltd v Bankstown Football Club Ltd
(1997) 187 CLR 384
Commissioner of Taxation v Ashwick (Qld) No 127 Pty Ltd & Ors
[2011] FCAFC 49
2011 ATC 20-255
Commissioner of Taxation v Bivona Pty Ltd
(1990) 21 FCR 562
21 ATR 151
90 ATC 4168
Commissioner of Taxation v Tasman Group Services Pty Ltd
(2009) 180 FCR 128
2009 ATC 20-138
74 ATR 739
Elder Smith & Co Ltd v Commissioner of Taxation (NSW)
(1931) 31 SR (NSW) 639
Equiticorp Industries Ltd v ACI International Ltd
[1987] VR 485
Equiticorp Finance Ltd (in liq) v Bank of New Zealand
(1993) 32 NSWLR 50
Fairway Estates Pty Ltd v Federal Commissioner of Taxation
(1970) 123 CLR 153
1 ATR 726
70 ATC 4061
Federal Coke & Co Pty Ltd v Federal Commissioner of Taxation
(1977) 15 ALR 449
7 ATR 519
77 ATC 4255
Federal Commissioner of Taxation v Sidney Williams (Holdings) Ltd
(1957) 100 CLR 95
[1957] HCA 1
Federal Commissioner of Taxation v Stone
(2005) 222 CLR 289
2005 ATC 4234
59 ATR 50
Federal Commissioner of Taxation v Total Holdings (Australia) Pty Ltd
(1979) 43 FLR 217
79 ATC 4279
9 ATR 885
GE Crane Sales Pty Ltd v Federal Commissioner of Taxation
(1971) 126 CLR 177
71 ATC 4268
2 ATR 692
Hobart Bridge Co Ltd v Federal Commissioner of Taxation
(1951) 82 CLR 372
[1951] HCA 33
HP Mercantile Pty Ltd v Commissioner of Taxation
(2005) 143 FCR 553
2005 ATC 4571
60 ATR 106
Investment and Merchant Finance Corporation Ltd v Federal Commissioner of Taxation
(1971) 125 CLR 249
71 ATC 4140
2 ATR 361
Magna Alloys & Research Pty Ltd v Federal Commissioner of Taxation
(1980) 33 ALR 213
80 ATC 4542
(1980) 11 ATR 276
Mills v Mills
(1938) 60 CLR 150
NEAT Domestic Trading Pty Ltd v AWB Ltd
(2003) 216 CLR 277
Newtronics Pty Ltd v Atco Controls Pty Ltd (in liq)
(2008) 69 ACSR 317
Orrong Strategies Pty Ltd v Village Roadshow Ltd
(2007) 207 FLR 245
Point v Federal Commissioner of Taxation
(1970) 119 CLR 453
1 ATR 577
70 ATC 4021
Ronpibon Tin NL & Anor v Federal Commissioner of Taxation
(1949) 78 CLR 47
Royal Botanic Gardens and Domain Trust v South Sydney City Council
(2002) 186 ALR 289
Tweddle v Federal Commissioner of Taxation
(1942) 180 CLR 1
Walker v Wimborne
(1976) 137 CLR 1
WP Keighery Pty Ltd v Federal Commissioner of Taxation
(1957) 100 CLR 66