ASHWICK (QLD) NO 127 PTY LTD & ORS v FC of T

Judges:
Ryan J

Court:
Federal Court, Melbourne

MEDIA NEUTRAL CITATION: [2009] FCA 1388

Judgment date: 26 November 2009

Ryan J

The corporate structure and history of the Foster's group

1. In 1982 Elder Smith Goldsbrough Mort Limited took over Henry Jones IXL Limited and changed its name to Elders IXL Limited. In 1983 the enlarged company took over Carlton & United Breweries Limited and conducted under a new name, Foster's Group Limited ("FGL") a diverse range of business including;

2. As at 30 June 1984 the structure of the Finance Group could have been represented in a simplified diagrammatic form by the following flow chart: 

Structure of Finance Group

3. Each of the entities in the Finance Group had its own charter which laid down certain limits subject to which it was required to trade. Those limits were directed to matters like gearing ratios, liquidity ratios, funding and borrowing limits, credit risk and trading and dealing limits. Each of those charters had been formulated by the Board of the relevant Finance Group subsidiary and approved by the Board of the parent company, FGL. The charters were reviewed and amended from time to time.

Acronyms and abbreviations

4. Throughout these reasons acronyms and abbreviations are generally used to refer to entities or expressions which recur with some

ATC 10358

frequency. In the case of corporate entities the full name of the company is set out immediately before the relevant acronym or abbreviation where it first occurs.
Expression or Entity Acronym or Abbreviation
Amayana Pty Ltd Amayana
AML Finance Corporation Limited AML Finance
Ashwick (Qld) No 127 Pty Ltd Ashwick
Bank Bill Rate BBR
EFG Australia Pty Ltd EFGA
EFG Financial Limited EFG Financial
EFG Investments Pty Ltd EFG Investments
EFG Securities Pty Ltd EFGS
EFG Treasury Pty Ltd EFGT
Elders Lensworth Finance Limited Group Lensworth
Elders Rural Finance Limited Elders Rural Finance
ELFIC Pty Ltd (formerly Elders Finance and Investment Co Limited) ELFIC
FBG Treasury Aust Pty Ltd FBGT
Foster's Group Ltd (formerly IXL Ltd) FGL
Harlin Holdings Pty Limited Harlin
Income Tax Assessment Act 1936 (Cth) the 1936 Act
Income Tax Assessment Act 1997 (Cth) the 1997 Act
Nexday Pty Ltd Nexday
Reduction of Assets Management Committee RAMCO
The Finance Group Collectively the subsidiaries of FGL which from time to time made up the Finance Group
The Foster's Group Collectively FGL and its subsidiaries from time to time including those gathered in the Finance Group
The respondent Commissioner of Taxation the Commissioner

The factual background

5. On 3 December 1984, EFGA Pty Ltd ("EFGA") was incorporated as a new holding company for the subsidiaries which comprised the Finance Group of FGL's subsidiaries. It was perceived that EFGA would have a higher credit rating than its subsidiaries separately enjoyed and would be able to borrow funds for the members of the Finance Group from external lenders more advantageously than those members individually could achieve. There was also some expectation that the holding company for the Finance Group might obtain a banking licence.

6. Before the incorporation of EFGA, ELFIC Pty Ltd (formerly Elders Finance and Investment Co Limited) ("ELFIC") had carried on the business of a merchant banker and its activities included the receiving of surplus funds on deposit from other members of the Finance Group and the making of advances by way of loans at a margin as required to members of the Finance Group. However, the greater proportion of ELFIC's income by way of interest was derived by loans to third parties.

ATC 10359

By 30 June 1994, ELFIC's gross assets had grown to $690 million.

7. After its incorporation and until about 2002, EFGA stood alone and separate from other entities in the Foster's Group as a corporation with its own statutory accounts. Also after its incorporation, EFGA succeeded to ELFIC's share of a US$500 million global note facility which had been raised as to US$300 million by FGL and as to US$200 million by ELFIC on behalf of the Finance Group. Upon its entry into that facility, EFGA, in February 1985, achieved a credit rating by Australian Ratings of A+. On 15 July 1985, a new charter was formulated for EFGA applicable to the whole of the Finance Group, each individual component of which was also given its own separate approved charter and cross-guarantees to a trustee were established between EFGA, ELFIC, Elders Rural Finance and Elders Lensworth Finance Limited Group ("Lensworth") which later became Lensworth Glenmore Park Limited and was a central company of the Lensworth Group which carried on the property finance business of the Elders Finance Group.

8. EFGA also succeeded to ELFIC's role as a licensed participant in the money market and a foreign exchange dealer. It took until 1 July 1986 for the legal and systems requirements for that transfer to be implemented. By 30 June 1987, EFGA's creditors and borrowings had grown to about $1.4 billion and by 30 June 1988 to about $2.3 billion.

9. Between 1985 and 1986, EFGA took over the conduct of treasury activities for the Finance Group. That involved it in making loans of about $700 million to ELFIC and $40 million to EFG Securities Pty Ltd ("EFGS") at benchmark rates like the Bank Bill Rate ("BBR") plus a margin. ELFIC in turn on-lent the funds to retail customers subject to credit limits set by the Board of EFGA and an obligation to submit monthly management reports to that Board. The fixing of interest rates charged to members of the Finance Group occurred at least annually and was intended to impose a discipline on EFGA executives to improve its performance as measured by a "profit" on the notional cost of capital employed. Finance Group subsidiaries were required to account for "losses" on defaulting loans to retail customers, which were set-off against "profits" derived from performing loans and other activities.

10. Mr Gerald John van Wyngen, who was the Director from 1986 to 1990 of EFG Treasury Pty Ltd ("EFGT") deposed to its activities during his directorship when he oversaw its five divisions;

EFGT had originally operated as a subsidiary of ELFIC but in July 1986 it passed into the direct control of EFGA.

11. Mr van Wyngen described EFGT as a "profit centre" with a budget requiring a return on capital employed after all expenses, including head office cost allocations. He gave evidence that in early 1986, the budget for EFGT required it to make a profit contribution of nearly $3 million (before tax) to ELFIC, with around $10 million in revenue, $6 million in direct operating expenses and $1 million in allocated central expenses. As at 31 May 1986, EFGT was approximately $300,000 behind budget in terms of its net contribution.

12. For the year ended 30 June 1988, EFGT made a direct management return (measured as revenue less transaction costs, standby costs, provisions and direct operating expenses) of $12.7 million. The return of EFGT's funding business, before overheads, was $8.5 million, compared with a budget of $2.4 million. For the year ended 30 June 1989, EFGT made a direct

ATC 10360

management return of $7.5 million, to which the funding business contributed $3.3 million. Following a report by PA Consulting Group dated 13 April 1989, the division of EFGT that conducted futures broking and trading was sold as it was no longer considered profitable.

13. According to Mr van Wyngen, EFGT raised funds from several external sources, including prime corporations (being companies with a rating of "A−" or higher) and banks in the money and term deposit markets, discounting bills of exchange, retail deposits from the pastoral and trustee businesses and overseas bank lines. The funding obtained was on a mix of terms (tenor), ranging from 11.00 am and 24 hour call, through to term deposits of 12 months or more. The rate of interest on these funds depended on the tenor and the then applicable interest yield curve across the range of maturity terms.

14. Each year, as part of the annual budgeting process, the Finance Group entities carrying on external lending activities forecast the funds required for each month over the following financial year. When funding was required, EFGT would process a pre-numbered deal ticket and provide the funds to the other entities, including ELFIC and EFGS, for lending to their customers. In April 1988, EFGT's Australian region balance sheet totalled $2.5 billion, which made it the biggest balance sheet for an Australian non-bank financial institution.

15. EFGT's strategy for maximising profit was to pursue opportunities to raise funds at the lowest possible cost, anticipate interest rate changes, lend at higher yields and manage foreign exchange and interest rate risk. Further considerations included the need to maintain sufficient liquidity to comply with banking covenants and to be in a position to provide the funds required by the borrowing entities within the Finance Group at relatively short notice, as well as managing prudently to protect against unexpected turmoil in financial markets.

16. According to Mr van Wyngen, a major technique by which profits were maximised was "gapping" or "mismatching". This involved anticipating movements in interest rates across a spread of maturity terms and exploiting differences between the rate at which money was borrowed by EFGT and on lent to external counterparties and other entities within the Finance Group, as well as Elders Resources Finance. This was managed across the portfolio by use of physical means like varying the tenor of liabilities and assets (such as bank and non-bank bills of exchange) and synthetic products, such as bank bill futures, forward rate agreements and interest rate swaps.

17. From around 1988, capital adequacy guidelines for banks were introduced by the Reserve Bank of Australia, which required their assets to be risk weighted and gearing limited to 12.5 times capital. This made funding cheaper for banks (which had a lower risk weighting), and more difficult to obtain and more expensive for non-bank financial institutions such as EFGA (which was not under the control of the Reserve Bank of Australia and had a higher risk weighting). From around 1988, Mr van Wyngen advised that EFGA should obtain a banking licence to avail itself of these benefits.

18. Lending transactions occurred between EFGT and external counterparties for the purpose of managing EFGT's liquidity. The counterparties were banks, prime merchant banks, finance companies and prime or near prime companies for which credit limits had been approved by credit personnel based in the Finance Group's Melbourne office. The loans were nearly always lent on "11 am" or "24 hour" call and were unsecured. The terms able to be agreed by EFGT were governed by an operating charter, which set out the lines of authority, operating limits, and approved product mixes.

19. Funding was provided to other entities in the Finance Group, such as ELFIC and EFGS, by way of loans at interest. From 1986 to 1990, the interest charged was normally calculated by applying a particular margin to the 90 day BBR on a monthly basis. In early 1986, the margin above BBR had been set at 0.7%. The margin was changed to 0.6%, with effect from October 1986. In addition, a charge was agreed to be paid by the borrowing entities for the facilities which were required to be held by the Finance Group to have sufficient liquidity to meet the funding requirements of the borrowing entities. Finally, a "penalty" rate was payable if the borrowing entity required materially less or

ATC 10361

more funding from EFGT than forecast in the budgets. Interest accruing on loans from EFGA (through EFGT) to other entities in the Finance Group was ordinarily calculated on a daily basis, and capitalised monthly.

20. Where funding was provided by EFGT to a borrowing entity for a specific loan by the borrowing entity to a customer, there was a risk of a differential between the timing of interest receipts and payments. Although interest was capitalised monthly on balances owed by the borrowing entities to EFGT, it was not paid until the borrowing entities received funds from their clients. However, EFGT was at liberty to exploit the interest rate risk in how it sought its own funding, for example by "gapping".

21. The term of loans to other entities in the Finance Group was 24 hour call except for matched funded loans or where specifically agreed otherwise. In substance, this meant that the money was rolled over from day to day, with the borrowing entity being responsible for repaying the loans irrespective of how it employed the funds. The loans to other entities in the Finance Group were unsecured.

22. Mr van Wyngen gave evidence that the amount and type of security required from customers was determined and administered by the borrowing entities as part of their normal external lending businesses. In all cases, the credit risk was borne by borrowing entities. If an amount was not paid by a customer, the borrowing entity remained liable to EFGT for principal and accrued interest on the loan provided by EFGT.

23. In late December 1989, Dresdner Bank agreed to purchase the business of EFGT (except for its funding operations). Mr van Wyngen transferred with the rest of the EFGT operations to Dresdner Australia, and was subsequently appointed Managing Director when the sale was completed in early 1990.

24. Between July 1985 and June 1986 the activities of companies in the Finance Group expanded considerably, enabling EFGA to report a profit for that financial year of approximately $34.2 million. By May 1987 the management of the Finance Group had been restructured along regional lines with a separate Regional Managing Director and Regional Board for each of Australia, New Zealand, Asia, the United Kingdom / Europe and the United States of America. Each region had its own treasury. By 30 June 1987, the total assets of the Finance Group had grown to approximately $4.1 billion and the net operating profit to about $64 million.

25. The share market crash of October 1987 thwarted a proposal to split the Foster's Group into four separate publicly-listed companies, one of which would have been the Elders Finance Group. Several companies in which the Finance Group had shareholdings were affected by the share market crash. However, there was little concern about the solvency of the Finance Group itself as its capital and reserves were regarded as sufficient to absorb those losses. In spite of the stock market crash and the abandonment of the proposed demerger of FGL, EFGA continued to grow steadily. In the year ended 30 June 1988, the Finance Group was the largest merchant banker in Australia, reporting a record profit of $63.4 million and assets of $5 billion and, as at 30 June 1989, EFGA had 141 subsidiaries principally in Australia and New Zealand with some located elsewhere in the world. In the three years ending 30 June 1989, EFGA's consolidated accounts recorded significant net operating profits for the Finance Group. In the same period ELFIC and EFGS earned substantial net income but incurred significant interest expenses almost exclusively on intra-group loans which were used as circulating capital in their businesses. In the year ended 30 June 1988, ELFIC suffered an operating loss of $15 million and a loss on extraordinary items of $24 million including a write-down in investments in subsidiaries (one of which was EFGS) of $19 million. In the same year EFGS suffered an operating loss of $12 million. However, not all the companies in the Finance Group sustained losses in that period. The Lensworth Group, with activities in the property sector, recorded increased operating profits in 1988 as a result of which the assets of the Lensworth Group increased by something of the order of 30%. By the year ended 30 June 1989, ELFIC's operating loss had grown to $86 million and that of EFGS to $8 million. EFGA, however, still recorded a consolidated profit for the Finance Group in the same year of $81 million, largely derived from the continuing profitability

ATC 10362

of the Lensworth Group. In June 1989, EFGA provided additional share capital of $80 million to ELFIC which, in turn, provided additional share capital of $20 million to EFGS. By that means both subsidiaries reported positive net assets as required to preserve their money market dealers' licences.

26. In late 1988, Australian Ratings downgraded EFGA's credit rating from "A+" to "BBB+" and in January 1989 indicated its intention to downgrade EFGA's credit rating further in response to concerns about the quality of its assets and the impact of new capital adequacy guidelines. Those guidelines required each bank to maintain a certain level of capital, depending on the risk weighting accorded to its assets. EFGA had a higher risk weighting because it was treated as a corporate borrower rather than a bank. As a result, lenders charged higher rates of interest to EFGA, which, in turn, had to charge its customers higher interest rates than those charged by banks.

27. Australian Ratings ultimately did not further downgrade EFGA's rating. Nevertheless, the Finance Group went ahead with plans to become a specialist merchant bank, entailing a cap on assets as at 30 June 1989 and a reduction in total assets of $1 billion by 30 June 1990. In the 1989 financial year, EFGA posted a consolidated profit before tax of $90 million. However, EFGS and ELFIC both suffered net operating losses and required capital injections from EFGA to enable the companies to report positive net asset positions and retain the licences required to operate their businesses. After the middle of 1989, FGL, at the request of EFGA, and prompted by external lenders' having declined to renew EFGA's debt financing, provided EFGA with a standby facility of $400 million at an interest rate of 2% above the BBR and on condition that EFGA reduced the facility to $250 million by October 1989. Although that reduction was apparently achieved, a further tightening of the liquidity of the Finance Group necessitated an increase, in December 1989, to $500 million in the standby facility provided by FGL to EFGA.

28. In August 1989, Harlin Holdings Pty Limited ("Harlin") launched a bid for FGL and subsequently attained a 55.82% shareholding. The takeover bid boosted the Finance Group's ability to access the funds required for the orderly sale of assets. However, the Finance Group's liquidity and funding position continued to decline in the face of increased customer defaults, a depressed economy and ongoing funding commitments. In August 1989, a $400 million standby loan facility was granted by FGL to EFGA, under which interest was charged at a margin of 2% above the then applicable BBR.

29. In November 1989, Australian Ratings downgraded FGL's credit rating to "BB/B.1" and EFGA's credit rating to "BB−/B.1". As a result, EFGA's loans no longer fitted the investment criteria of its major lenders and banks began to withdraw funding. After the downgrade, the Board of EFGA agreed to accelerate the strategic sell-down of the Finance Group's assets in order to continue its operations. A steering committee was formed to downsize the Australian and New Zealand businesses and coordinate reductions and sell-offs in other regions. Between January and March 1990, the steering committee oversaw the sale of the Finance Group's assets. During this period, the Finance Group subsidiaries cut back their lending activities and concentrated on funding existing committed liabilities. However, EFGA continued, where required, to make loans at a margin to the Finance Group subsidiaries.

30. In March 1990, FGL announced its plan to focus solely on its brewing business and divest itself of all of its other businesses, including those conducted by the Finance Group. As a result, many lenders to the Finance Group, caught off-guard by the announcement, sought to switch existing external lines of credit to FGL. At that stage, external funding of the Finance Group was over $3 billion. In order for EFGA to realise the Finance Group's assets and maximise shareholder returns, it became necessary to repay facilities as they matured and, to the extent that asset sales could not fund this, to draw on alternative funding from FGL. Between February and April 1990, funding to EFGA by FGL doubled to approximately $301 million.

31. On 22 March 1990, the Board of EFGA established the Reduction of Asset Management Committee ("RAMCO") to facilitate the

ATC 10363

expeditious realisation of assets, disposal of businesses and repayment of debt. RAMCO had equivalent authority to the EFGA Board and continued to meet till July 2004. In May 1990, the directors of the companies in the Finance Group called on FGL to provide them with letters of comfort so that they could sign the statutory accounts referable to companies in the Finance Group.

32. By 30 June 1990, the Finance Group's assets had fallen to $2.7 billion following the sale of the Australian treasury operation, the Australian trustee business and stockbroking businesses in Australia, New Zealand and the United Kingdom. At this stage, the realisation of the Finance Group's assets was expected to be completed by 30 June 1990. The debt owed by EFGA to the Foster's Group was now $435 million, comprising the sum of direct liabilities of $417 million and bank borrowings transferred from EFGA to the Foster's Group of $18 million. This was forecast to increase to $820 million by 31 July 1990 and, thereafter, gradually reduce and be fully repaid by 30 June 1992. The increase in debt to the Foster's Group was largely the result of external bank funding being withdrawn or not being renewed and facilities being transferred to, or replaced by, new funding from the Foster's Group. As well, FGL provided a guarantee of performance of the obligations of Finance Group companies to certain creditors to preserve lines of credit from those creditors. That was done rather than increasing the share capital of the Finance Group companies because of the risk that such equity funds might have become available to third party litigation creditors of companies in the Finance Group. Until this time, EFGA had been charging the Finance Group companies at its cost of borrowing plus a margin of 0.6%. From 1 September 1990, EFGA continued to charge interest but provided further moneys at cost of funds with no margin.

33. In July 1990, another wholly owned subsidiary of FGL, Amayana Pty Ltd ("Amayana") made a loan of $34.8 million to EFGA using funds which Amayana had borrowed from its subsidiary, FBG Treasury Aust Pty Ltd ("FBGT"). Both the loan from FBGT to Amayana and that from Amayana to EFGA were at the standard intra-company interest rates charged by FBGT.

34. The refinancing of the Finance Group's commitments during the latter half of 1990 became a major drain on FGL's funds. However, had ELFIC, Lensworth or Elders Rural Finance defaulted under the US$ Denominated Note Global Facility noted at [0] above, cross-default clauses could have been triggered imperilling the financial viability of the whole Foster's Group.

35. Money raised from the sale of assets to external purchasers and the transfer of assets to other members of the Foster's Group, as well as from the repayment of customer loans, was used at this time to repay bank loans, to continue funding to external customers where appropriate and, to the extent available, to repay funding provided by the Foster's Group. However, the necessity of acquiring assets from debtors in settlement of their debts hindered the Finance Group's realisation program because such property assets had to be managed and took time to realise. By July 1990, the Board of EFGA had formed the view that, because of the depressed Australian property market, the Lensworth Group's property book could not be sold at that time except on "fire sale" terms and prices. Other assets of the Finance Group were sold off, more than half of them by June 1990, and those sales enabled the balance of debts owed to EFGA by members of the Finance Group, other than ELFIC, EFGS and Lensworth, to be reduced to nil by 1992.

36. EFGA continued to lend to Finance Group subsidiaries to fund their existing liabilities to external customers where termination of the facilities could not be negotiated, and continued lending to customers if the further amount would not only be repaid but also assist the recovery of the entire amount outstanding. Up until around July 1992, RAMCO's terms of reference did not impose limits on the amounts that could be advanced to existing customers, although they were typically loans of under $1 million. In July 1992, RAMCO's terms of reference were amended and authority limits were introduced formalising the process for approving additional loans to existing customers. These additional loans to existing customers were funded by loans from EFGA to the relevant Finance Group subsidiaries (including ELFIC and EFGS). Generally, the sources of the funds for

ATC 10364

these additional loans were either the proceeds of asset realisations, or funds drawn by EFGA from the Foster's Group.

37. During 1991, the Finance Group suspended customer accounts for non-performing loans, ceasing to record interest as income where there were doubts about the relevant customers' ability to continue paying interest. This impinged on EFGA's profit and loss statement as funding costs continued to be recognised. However, the customers were still expected to repay the principal amount and the suspended interest.

38. In March 1991, EFGA reported a deficiency of shareholders' funds. This was due to the allocation of significant provisions to closing down costs and doubtful debts. Furthermore, the interest payable to the Foster's Group on funds advanced to the Finance Group exceeded the interest received from customers whose loan accounts had been suspended.

39. In April 1991, EFGA made a request to the Foster's Group for $400 million in interest-free funding, in order to eliminate a budgeted loss for the 1992 financial year and to prevent external auditors from requiring additional provisioning of $60 million in the Finance Group accounts. That proposal was rejected by the Board of FGL.

40. In early 1991, concerns were also raised about the unsecured nature of loans provided by the Foster's Group to the Finance Group, which would rank equally with the debts of any litigation creditors. As the level of debt rose, obtaining security for the debts owing by EFGA to the Foster's Group was made a priority. By this stage, the amount due to the Foster's Group had increased to nearly $1.4 billion, vastly exceeding the original forecast of $820 million. This was attributed to a slowdown in asset sales as a result of the economic downturn, and a miscalculation of the volume and speed at which the banks would withdraw their funding support of the Finance Group.

41. Pursuant to the refinancing arrangements, EFGT became, in May 1991, the funding conduit to EFGA. The Foster's Group took security over EFGT's assets in respect of the debt owed by EFGT to the Foster's Group. In turn, EFGA and certain Finance Group subsidiaries guaranteed EFGT's obligations to the Foster's Group and granted charges over their assets to support those guarantees. The Foster's Group thereby became a secured lender with an entitlement to realise the assets of EFGT and the Finance Group subsidiaries should EFGT default in its repayment obligations, enabling the Foster's Group to continue to fund the Finance Group without exposing the additional loan funds to the claims of third party litigants. From October 1991, loans were made by the Foster's Group to the Finance Group through EFGT under a Security Note arrangement. EFGA and some of its subsidiaries, including ELFIC and EFGS guaranteed repayments by EFGT under these arrangements and gave charges over their assets to secure their obligations under the guarantees. The effect of these arrangements was to cause loans by FGL to EFGA and AML Finance Corporation Limited ("AML Finance") and by AML Finance to EFGA to be repaid and replaced with loans by FGL to EFGT secured over the bulk of the assets of EFGA and its subsidiaries in the Finance Group and by EFGT to EFGA.

42. By 30 June 1991, it had become apparent that EFGA, ELFIC and EFGS each had, or was likely to have, a deficiency of net assets of $194 million, $808 million and $40 million respectively. On 12 August 1991, the FGL Board gave "in-principle" approval to the provision of a letter of comfort to the Finance Group subsidiaries. The directors of EFGA, ELFIC and EFGS subsequently formed the view that those companies would be able to pay their debts as and when they fell due, and signed off on their accounts.

43. By September 1991, the recession was hindering the asset realisation program and increasing the incidence of defaults by customers unable to meet their repayment obligations to the Finance Group companies. Price Waterhouse, as auditors of EFGA, concluded that general provisions should be increased by between $35 million to $50 million above the existing provisions of $62 million. FGL had made a loss of $43 million in the year ended 30 June 1991 and had no accumulated distributable reserves. As payment of a dividend without the consent of lenders could have been a breach of banking covenants,

ATC 10365

the FGL Board resolved not to pay a dividend for the 1991 financial year.

44. After the security structure noted at [0] above had been implemented in October 1991, it was decided to pursue an orderly realisation of the Finance Group's assets rather than aggressively selling down those assets. Between 1991 and 1998, the performance of the remaining assets of the Finance Group continued to be monitored by RAMCO and, as thought appropriate, Finance Group companies were directed to foreclose on securities held over properties of defaulting external borrowers. Additional finance was provided by EFGA to some external customers to enable them to maintain assets which could not yet be sold at acceptable prices. Although the asset realisation program had, by mid 1992, bought about an improvement in the net liability position of the Finance Group, it was perceived by then that the program would have to be extended to mid 1997 before it could be completed.

45. After Australia, the United Kingdom and the United States had gone into recession in 1991, the Board of EFGA determined that the Lensworth Group's property business should be realised over a period of time with the other residual assets of the Finance Group. Accordingly, the RAMCO and Lensworth Group assets were brought under one management organisation and the time frame for the orderly realisation strategy was extended to between five and seven years.

46. Before 1992, the advances from the Foster's Group to the Finance Group had outstripped the repayments. However, after July 1992, the Finance Group's principal repayments and interest payments to the Foster's Group outpaced the additional advances. The cash was being generated from realising loans, selling assets where the Finance Group had security and selling other assets and businesses of the Finance Group. By December 1991, the undrawn funding commitments of the Finance Group had dropped from $900 million to $185 million.

47. In June and August 1992, in response to concerns about EFGA's solvency, all staff were transferred from EFGA to EFGT. The human resources reshuffle coincided with Harlin's going into receivership on 6 July 1992 and the acquisition of its shares in the Foster's Group by BHP Limited.

48. In September 1992, the Board of FGL approved an increase in provisioning of $360 million to cover additional specific provisions, additional general provisions and work out costs, and $300 million for future funding costs. At about the same time, FGL provided another letter of comfort to enable the Finance Group directors to sign off on their respective company accounts. Over time, a portion of the provisions was in fact reversed, thereby realising profits for the Finance Group. On 15 September 1992, FGL made a rights issue to raise new capital which was successful in raising $1 billion. That enabled a large portion of FGL's debt to be repaid and effectively brought FGL's liquidity problems to an end.

49. Throughout 1993 and 1994, the continuation of the asset realisation program resulted in a net cash outflow from the Finance Group to the Foster's Group. New strategies were developed to maximise the realisable value of assets over which the Finance Group had security before the Finance Group decided, in 1995, to retain the land holdings which had been acquired in order to enhance their value through rezoning and development. Nevertheless, EFGA continued to make losses, except for the 1995 year, generally due to provisions for the decline in value of investments and loans and bad debt write-offs. ELFIC and EFGS continued to record losses because their intra-company debts exceeded income from their business activities.

50. Despite this progress, it remained necessary to obtain comfort that the Foster's Group would continue to provide financial support to the Finance Group companies that were net asset deficient so that the directors of those companies could sign off on the statutory accounts.

51. It was at around this time that EFG Financial Limited ("EFG Financial"), a subsidiary of ELFIC Holdings BV and a Finance Group company incorporated in Cyprus, was in the process of being sold. As at 31 March 1996, EFG Financial's trial balance recorded debts owing to it by EFGA in the amounts of US$66,306,653.04 and

ATC 10366

US$35,620,265.31. In preparation for the sale of ELFIC Holdings BV and its subsidiaries, the debts owed by EFGA to EFG Financial were assigned from EFG Financial to Amayana for $1. Under the security structure described at [0] above, FGL continued, until 30 June 1998, to charge interest on its loans to EFGT. In turn, EFGT continued to charge interest on its loans to EFGA. The existing loans from Amayana to EFGA remained unpaid and were unsecured. The loans by FGL to EFGT were at interest and the interest so charged was returned as assessable income by FGL. From time to time, EFGT made payments and repayments reducing the balance of its debts from about $1,143 million to about $842 million by 30 June 1998. Subsequent payments by EFGT between 1999 and 2001 amounted to $61,830,522. EFGT, in turn, charged interest on intra-group loans from it to, in particular, EFGA. That interest was included in EFGT's assessable income. Substantial payments and repayments on account of those debts were made by EFGA to EFGT between October 1991 and 30 June 1998.

52. Loans were also made at interest from FBGT to Amayana which on-lent the borrowed funds, also at interest, to EFGA. The interest was included in Amayana's assessable income. Although payments and repayments were made from time to time on behalf of EFGA to Amayana, EFGA's total indebtedness to Amayana rose from about $251 million in 1991 to about $325 million in 1998.

53. EFGA made available to subsidiaries in the Finance Group, particularly ELFIC and EFGS, the funds which it had borrowed from EFGT and Amayana. EFGA charged interest to the borrowers and returned such interest as assessable income.

54. In early 1998, Mr Neufeld, who was Senior General Manager within the Finance Group from 1995 to 2001, conducted a "recoverability review" to assess the prospects of recovering debts owed respectively by ELFIC and EFGS to EFGA, by EFGA to EFGT and by EFGT to FGL. He assessed ELFIC's "best case" recovery at $92 million being $54 million from external customers and $38 million from related party customers. In the same way, Mr Neufeld assessed the "best case" recovery of EFGS at $6 million, all from one external customer, and that of EFGA at $197.2 million from all assets, not merely from loans to ELFIC and EFGS. EFGT's "best case" recovery was similarly assessed at $208 million, all from related party customers. In the light of those assessments, Mr Neufeld thought that, of the amount of $1.29 billion owed by ELFIC to EFGA, $1.2 billion should be written off as a bad debt. Similarly, he recommended that $99 million of the $106 million owed by EFGS to EFGA should be written off and $657 million of $850 million owed by EFGA to EFGT should be written off. Mr Neufeld considered that $268 million of the debt of $843 million owed by EFGT to FGL was recoverable. He also recommended that the interest on the outstanding balance in each instance be reduced to nil. In substance, those recommendations as to write-offs were adopted. As well, in the 1999 financial year, Amayana wrote off as bad the entirety of the debt owed to it by EFGA apart from the assigned debts acquired by Amayana from EFG Financial; see [0] above. The write-off was said to be justified by the fact that any proceeds from the realisation of debts due to EFGA and its subsidiaries were to be applied in repayment of secured loans to EFGA from EFGT which, in turn, was obliged to use the repayments to it in reduction of its liabilities to FGL.

55. From September 1997, and during 1998, an allocation of repayments made by EFGS and ELFIC to EFGA, by EFGA to EFGT and by EFGT to FGL was undertaken on the basis that repayments specifically appropriated to a particular debt or loan should be applied in reduction or elimination of that debt or loan. Remaining payments attributed to interest were allocated to reduction of interest liabilities on a first-in first-out basis and any surplus was applied in reduction of unpaid principal and interest also on a first-in first-out basis. If any balance remained, that was also allocated to repayment again on a first-in first-out basis, of outstanding principal and unpaid interest. After that process had been completed, the balance (if any) assessed by Mr Neufeld as part of the "recoverable amount" was notionally applied, also on a first-in first-out basis, to reduction of the outstanding liabilities for principal and unpaid interest.

56.

ATC 10367

The interest charged by EFGA to ELFIC and EFGS, by EFGT and Amayana to EFGA, by FGL to EFGT and by FBGT to Amayana was treated as an expense in the profit and loss statements of each of the debtor companies. ELFIC and EFGS claimed deductions for the same interest from their assessable incomes and those deductions were included in the losses said to have been incurred by those companies which were transferred to other companies in the Foster's Group.

57. Similarly, EFGA claimed deductions for unpaid principal and interest due from ELFIC and EFGS which had been written off as bad debts. The unpaid interest component of those debts had previously been returned by EFGA as assessable income. EFGA also claimed deductions from its assessable income of liabilities for interest which it had incurred to Amayana. The combined deductions claimed by EFGA resulted in tax losses which were transferred to other companies in the Foster's Group.

58. EFGT and Amayana, in turn, claimed deductions for the interest charged on loans to them from FGL and FBGT. Having respectively included in their assessable incomes from 1992 to 1998 interest on loans made to EFGA, they claimed deductions in respect of the interest due from that company which had later been written off as bad. There was no claim for a deduction by either EFGT or Amayana of amounts of principal due from EFGA which had been written off as bad. However, the deductions claimed by EFGT and Amayana contributed to tax losses which were subsequently transferred to other companies within the Foster's Group.

59. Correspondingly, FGL had included in its assessable income from 1992 interest on loans which it had advanced to EFGT. It claimed a deduction in 1998 in respect of interest on those loans which had been written off as bad which contributed to another tax loss which was also transferred to another company within the Foster's Group.

60. The accounts for EFGT for the year ended 30 June 1996 recorded a loss of $1.1 billion resulting from a large provision for doubtful debts in relation to the receivables due from EFGA to reflect the likely level of recovery. In August 1996, the Board of EFGT agreed to make a provision for $1.12 billion and the Board of FGL provided further confirmation of its ongoing support.

61. To address the fact that all operating Finance Group entities had become net asset deficient by 31 October 1996, Lensworth Group Limited was established. On 26 March 1997, Lensworth Group acquired from EFGT the shares in the parent companies of the various land holding entities and late in that year the profits derived by Lensworth Group ceased to be reported as abnormal items and were disclosed as ordinary income of the Foster's Group on the basis that the property development activities by then constituted an ongoing business.

62. The Foster's Group continued to charge interest on the existing debts owed by the Finance Group even though the interest was extremely unlikely to be recovered. That course of action was justified on the basis that the realisation process was drawing to a close and the litigation risks appeared to have reduced with the settlement of several matters.

63. As at 30 June 1998, ELFIC owed EFGA debts totalling $1,294,441,115. On 19 June 1998, the $1,202,441,115 that ELFIC could not pay or repay EFGA was written off as bad, and the interest rate on the debts reduced to nil per cent per annum by the Board of EFGA with effect from 30 June 1998.

The Commissioner's assessments, the applicants' objections and the present proceedings

(i) ELFIC

64. On 18 December 2007, the Commissioner issued an assessment to ELFIC in respect of each of the tax years ended 30 June 1995, 1996 and 1997 determining that the respective amounts of $95,293,880, $106,399,661 and $93,156,592, each "being a tax benefit that is referrable to ELFIC … (the taxpayer) … shall not be allowable to the taxpayer in relation to that year of income." An objection by ELFIC to each of those assessments was disallowed on 9 February 2007 when the Commissioner also declined to remit the penalty tax imposed on ELFIC under Division 10 of Part VII of the 1936 Act. The

ATC 10368

reasons for disallowing ELFIC's objections were expressed as follows:

" INTEREST DEDUCTION CLAIM

During the year of income ended 30 June 1995 ('the relevant year'), ELFIC Pty Ltd ('the Taxpayer') was a member of a large corporate group ('the Group').

The Taxpayer has claimed, in the relevant year, a deduction amount totalling $95,293,880 on account of amounts of unpaid interest on debts allegedly owing by the Taxpayer to another entity within the Group. The Taxpayer argues that the amount of $95,293,880 is deductible in the relevant year under subsection 8-1(1) of the Income Tax Assessment Act 1997 ('the ITAA 1997').

The Commissioner contends that the interest amount claimed in the relevant year as a deduction is not deductible under subsection 8-1(1) of the ITAA 1997, or the equivalent provision of the Income Tax Assessment Act 1936 ('ITAA 1936'), for the following reasons:

  • (a) the unpaid interest was not a loss or outgoing -
    • i) incurred in gaining or producing assessable income; or
    • ii) necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income.
  • (b) the interest was capital, or capital in nature.

PART IVA AND ITS APPLICATION.

Further or alternatively, if the purported interest deduction of $95,293,880 was deductible for the year ended 30 June 1995, under subsection 8-1(1) of the ITAA 1997 or the equivalent provision of the ITAA 1936, which the Commissioner does not concede, the Commissioner contends that the provisions of Part IVA of the ITAA 1936 apply to disallow that deduction. In consequence, the Commissioner has made a valid determination under paragraph 177F(1)(b) of the ITAA 1936. The determination was issued to the taxpayer on 12 December 2006."

The appeals to this Court against the disallowance of the three objections in respect of ELFIC are proceedings respectively numbered VID 130, 133 and 134 of 2007.

(ii) EFGS

65. The assessment for this taxpayer was issued on 18 December 2006 in respect of the tax year ended 30 June 1997. It was determined that EFGS was not entitled to a deduction in that year of $6,804,054 being interest on loans from EFGA. An objection to that assessment was disallowed on 9 February 2007 for the same reasons, mutatis mutandis, as those given in relation to ELFIC which are reproduced at [0] above. The appeal to this Court against the objection by EFGS to that assessment is the proceeding numbered VID 135 of 2007.

(iii) EFGA

66. The Commissioner's assessment in respect of EFGA was also issued on 18 December 2006 and related to the tax year ended 30 June 1998. It was determined that EFGA was not entitled to a deduction for that year in respect of bad debts written off on account of debts totalling $1,202,441,116 owed to EFGA by ELFIC and a further $100,009,231 owed to EFGA by EFGS. That claim to a deduction was described in the Commissioner's notice dated 9 February 2007 of disallowance of an objection to the assessment as the "bad debts claim". In his reasons for the decision to disallow the objection in respect of the bad debts claim the Commissioner recited:

"BAD DEBTS CLAIM

In respect of the debts allegedly bad and written off in the relevant year, the Commissioner contends that the Taxpayer is not entitled to a deduction under subsection 25-35(1) or subsection 8-1(1) of the ITAA 1997."

67. The same reasons gave this explanation of the application to the bad debts claim of Part IVA of the 1936 Act:

"BAD DEBTS CLAIM

Further or alternatively, if the alleged amount of $1,302,450,347 claimed as bad debts was deductible for the year ended 30 June 1998, under subsection 25-35(1) or subsection 8-1(1) of the ITAA 1997, which the Commissioner does not concede, the

ATC 10369

Commissioner contends that the provisions of Part IVA of the ITAA 1936 apply to disallow that deduction. In consequence, the Commissioner has made a valid determination under paragraph 177F(1)(b) of the ITAA 1936. The determination was issued to the taxpayer on 12 December 2006."

68. In the same assessment the Commissioner determined that EFGA was not entitled to a deduction in the 1998 tax year for interest totalling $82,681,730 owing by EFGA to other entities within the Foster's Group. That claim was described in the notice of disallowance of EFGA's objection as the "interest deduction claim". The following reasons were given for the decision to disallow the objection in respect of that claim:

"INTEREST DEDUCTION CLAIM

The Commissioner contends that the interest amount claimed in the relevant year as a deduction is not deductible under subsection 8-1(l) of the ITAA 1997 for the following reasons:

  • (a) the unpaid interest was not a loss or outgoing
    • i) incurred in gaining or producing assessable income; or
    • ii) necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income.
  • (b) the interest was capital, or capital in nature.

… … …

PART IVA AND ITS APPLICATION.

INTEREST DEDUCTION

Further or alternatively, if the purported interest deduction of $82,681,730 was deductible for the year ended 30 June 1998, under subsection 8-1(1) of the ITAA 1997, which the Commissioner does not concede, the Commissioner contends that the provisions of Part IVA of the Income Tax Assessment Act 1936 ('the ITAA 1936') apply to disallow that deduction. In consequence, the Commissioner has made a valid determination under paragraph 177F(1)(b) of the ITAA 1936. The determination was issued to the taxpayer on 12 December 2006."

EFGA's appeal against the disallowance of its objection has been brought as proceeding number VID 132 of 2007 in this Court.

(iv) FGL

69. The Commissioner's assessment in respect of FGL issued on 18 December 2006 and disallowed a claimed deduction for bad debts written off. The objection to that assessment was disallowed on 9 February 2007 and the Commissioner's statement of reasons for that decision recited;

" BAD DEBTS CLAIM

During the year of income ended 30 June 1998 ('the relevant year'), Foster's Group Limited ('the Taxpayer') was a member a large corporate group ('the Group').

The Taxpayer has claimed that, during the relevant year, it was entitled to a deduction amount of $401,058,393 under paragraph 25-35(1)(a) or subsection 8-1(1) of the Income Tax Assessment Act 1997 ('the ITAA 1997') in respect of debts allegedly owed to it and written off.

In respect of the debts allegedly bad and written off in the relevant year, the Commissioner contends that the Taxpayer is not entitled to a deduction under paragraph 25-35(1)(a) or subsection 8-1(1) of the ITAA 1997.

PART IVA AND ITS APPLICATION.

Further or alternatively, if the alleged amount of $401,058,393 claimed as bad debts was deductible for the year ended 30 June 1998 under paragraph 25-35(1)(a) or subsection 8-1(1) of the ITAA 1997, which the Commissioner does not concede, the Commissioner contends that the provisions of Part IVA of the Income Tax Assessment Act 1936 ('the ITAA 1936') apply to disallow that deduction.. In consequence, the Commissioner has made a valid determination under paragraph 177F(1)(b) of the ITAA 1936. The determination was issued to the taxpayer on 12 December 2006."

ATC 10370

FGL's appeal to this Court against the disallowance of its objection to the assessment is the proceeding numbered VID 129 of 2007.

(v) Amayana

70. The Commissioner's assessment in respect of this taxpayer for the 1998 tax year was issued on 18 December 2008 and disallowed a claimed deduction of $16,875,354 in respect of interest on loans from FBGT to Amayana. An objection to that assessment was disallowed on 9 February 2007. The Commissioner's reasons as recited in the notice of disallowance were:

"The Commissioner contends that the interest amount claimed in the relevant year as a deduction is not deductible under subsection 8-1(1) of the ITAA 1997 for the following reasons:

  • (a) the unpaid interest was not a loss or outgoing -
    • i) incurred in gaining or producing assessable income; or
    • ii) necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income.
  • (b) the interest was capital, or capital in nature.

PART IVA AND ITS APPLICATION.

Further or alternatively, if the purported interest deduction of $16,875,354 was deductible for the year ended 30 June 1998 under subsection 8-1(1) of the ITAA 1997, which the Commissioner does not concede, the Commissioner contends that the provisions of Part IVA of the Income Tax Assessment Act 1936 ('the ITAA 1936') apply to disallow that deduction. In consequence, the Commissioner has made a valid determination under paragraph 177F(1)(b) of the ITAA 1936. The determination was issued to the taxpayer on 12 December 2006."

Amayana's appeal from the disallowance of its objection has been constituted by the proceedings in this Court numbered VID 128 of 2007.

(vi) Ashwick

71. The Commissioner disallowed the deduction of $30,213 claimed by Ashwick (Qld) No 127 Pty Ltd ("Ashwick") in the 1997 year as a result of the transfer of a tax loss from ELFIC to Ashwick, another wholly owned subsidiary of FGL. An objection to that determination or assessment was disallowed on 9 February 2007. The Commissioner's reasons as recited in the notice of disallowance were:

"Certain entities within the Group ('the Entities') had allegedly incurred tax losses during the relevant year or prior to the relevant year. One of the Entities ('the loss company') had claimed that, pursuant to a Loss Grouping Agreement, it had transferred to the Taxpayer a tax loss of $30,213 during the relevant year.

The Commissioner disputes that tax losses were incurred by the loss company. Accordingly, the Commissioner considers that, as no tax losses were available for transfer to the Taxpayer during the relevant year, the Taxpayer's claim for a deduction under sections 170-20 and 36-17 of the Income Tax Assessment Act 1997 ('the ITAA 1997') or the equivalent provisions under the Income Tax Assessment Act 1936 ('ITAA 1936') must fail.

PART IVA AND ITS APPLICATION.

Further or alternatively, if the purported tax loss transfer of $30,213 from the loss company to the Taxpayer was effective for the year ended 30 June 1997 and the taxpayer would have been entitled to a deduction pursuant to sections 170-20 and 36-17 of the ITAA 1997, which the Commissioner does not concede, the Commissioner contends that the provisions of Part IVA apply to disallow that deduction. In consequence, the Commissioner has made a valid determination under paragraph 177F(1)(b) of the ITAA 1936. The determination was issued to the Taxpayer on 12 December 2006."

The appeal against the disallowance of Ashwick's objection in respect of that tax loss transfer is constituted by the proceedings in this Court numbered VID 123 of 2007.

72. The Commissioner, by an assessment issued on 18 December 2006, similarly disallowed the deduction claimed by Ashwick

ATC 10371

in the 1998 year as a result of the transfer of a tax loss from FGL to Ashwick. An objection to that assessment was disallowed on 9 February 2007. The Commissioner's reasons, as recited in the notice of disallowance, were, mutatis mutandis, the same as those reproduced at [0] above. Ashwick's appeal against that disallowance is constituted by the proceedings in this Court numbered VID 124 of 2007.

73. By a notice of amended assessment issued on 21 December 2006, the Commissioner disallowed the deduction of $145 claimed by Ashwick for the year ended 30 June 2001 as a result of the transfer to Ashwick from EFGA and EFGT of tax losses of $70 and $75 respectively. An objection to that amended assessment was disallowed on 9 February 2007. The Commissioner's reasons, as recited in the notice of disallowance were, mutatis mutandis, the same as those reproduced at [0] above. Ashwick's appeal against that disallowance is constituted by the proceedings in this Court numbered VID 125 of 2007.

74. The Commissioner had earlier disallowed the deductions of $70 and $75 for the tax year ended 30 June 2001 which are referred to at [0] above. On 27 October 2005 Ashwick objected to that disallowance and, by notice dated 31 May 2006, was advised by the Commissioner that "As 60 days have now passed since the Commissioner was given the notice [of objection], the Commissioner is taken to have disallowed the objection." Ashwick's appeal against that deemed disallowance is constituted by the proceedings in this Court numbered VID 861 of 2006.

(vii) Nexday

75. By an assessment issued on 18 December 2006, the Commissioner disallowed the deduction of $139,200 claimed by another wholly owned subsidiary of FGL, Nexday Pty Ltd ("Nexday") in the tax year ended 30 June 2000 in respect of A tax loss transferred to Nexday by Amayana. Nexday's objection to that assessment was disallowed on 9 February 2007. The Commissioner's reasons as stated in the notice of disallowance included this statement:

"The Commissioner disputes that tax losses were incurred by the loss company. Accordingly, the Commissioner considers that, as no tax losses were available for transfer to the Taxpayer during the relevant year, the Taxpayer's claim for a deduction under sections 170-20 and 36-17 of the Income Tax Assessment Act 1997 ('the ITAA 1997') must fail."

In the same notice the Commissioner contended, further or in the alternative, that Part IVA of the 1936 Act applied to disallow the claimed deduction. Nexday's appeal to this Court against the disallowance of its objection is constituted by proceedings numbered VID 126 of 2007.

(viii) EFGT

76. On 18 December 2006 the Commissioner issued an assessment disallowing EFGT's claim for a total deduction in the year ended 30 June 1998 of $572,774,838 in respect of a liability for interest and for bad debts owing to EFGT from EFGA which had been written off. EFGT objected to the assessment in relation to both aspects of the claimed deduction and on 9 February 2007 the Commissioner disallowed the objection. The reasons as stated in the notice of disallowance included this statement related to the interest deduction claim:

"The Commissioner contends that the interest amount claimed in the relevant year as a deduction is not deductible under subsection 8-1(1) of the ITAA 1997 for the following reasons:

  • (a) the unpaid interest was not a loss or outgoing:
    • i) incurred in gaining or producing assessable income; or
    • ii) necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income.
  • (b) the interest was capital, or capital in nature."

In relation to the bad debts claim the Commissioner's reasons recited:

"In respect of the debts allegedly bad and written off in the relevant year, the Commissioner contends that the Taxpayer is not entitled to a deduction under paragraph 25-35(1)(a) or subsection 8-1(1) of the ITAA 1997."

ATC 10372

As well, the Commissioner invoked Part IVA of the 1936 Act in support of his further or alternative contention that it applied to disallow each of EFGT's interest deduction and the bad debts claim. EFGT's appeal to this Court against the disallowance of its objection is constituted by proceedings numbered VID 131 of 2007.

(vix) EFG Investments

77. On 18 December 2006 the Commissioner issued an assessment disallowing a deduction claimed by EFG Investments in the tax year ended 30 June 1996 in respect of tax losses which had been transferred to EFG Investments by EFGS. EFG Investments objected to that assessment and, on 9 February 2007, the Commissioner disallowed the objection. The statement of reasons set out in the notice of disallowance included these paragraphs:

"Certain entities within the Group ('the Entities') had allegedly incurred tax losses during the relevant year or prior to the relevant year. One of the Entities ('the loss company') had claimed that, pursuant to a Loss Grouping Agreement, it had transferred to the Taxpayer a tax loss of $739,340 during the relevant year.

The Commissioner disputes that tax losses were incurred by the loss company. Accordingly, the Commissioner considers that, as no tax losses were available for transfer to the Taxpayer during the relevant year, the Taxpayer's claim for a deduction under sections 170-20 and 36-17 of the Income Tax Assessment Act 1997 ('the ITAA 1997') or the equivalent provisions under the Income Tax Assessment Act 1936 ('ITAA 1936') must fail."

The Commissioner also contended, further or alternatively, that Part IVA of the 1936 Act applied to disallow the claimed deduction for transferred tax losses. EFG Investments' appeal against the disallowance of its objection is constituted by the proceedings in this Court numbered VID 127 of 2007.

The common issues

78. It will be seen from the foregoing summary of the assessments and objections that the present appeals give rise to four main issues:

It is convenient to examine each of those issues separately and in order making, as required in relation to specific taxpayers, findings of fact in addition to those summarised from [0]-[0] above.

The deductibility of bad debts written-off

79. Various members of the Foster's Group claimed deductions in the 1998 year of income for writing off as bad debts amounts of unpaid principal or interest on loans made to other members of the Foster's Group. The bad debts for which deductions were so claimed have been indicated in the following tabular form in written submissions filed on behalf of the Commissioner:

" Taxpayer Income Year Amount of deduction
FGL 1998 $401,058,393 (unpaid interest on loans to EFGT)
EFGT 1998 $525,260,163 (unpaid interest on loans to EFGA)
Amayana 1998 $133,165,341 (unpaid interest on loans to EFGA)

ATC 10373

EFGA		 1998 $1,2X02,441,116 (unpaid principal and interest on loans to ELFIC)
EFGA 1998 $100,009,231 (unpaid principal and interest on loans to EFGS)"

(i) The statutory provisions

80. The first statutory provision which bears on this issue is s 25-35(1) of the 1997 Act which provides:

"You can deduct a debt (or part of a debt) that you write off as bad in the income year if:

  • (a) it was included in your assessable income for the income year or for an earlier income year; or
  • (b) it is in respect of money that you lent in the ordinary course of your business of lending money."

81. The other, more generally applicable, provision of the 1997 Act under which the bad debts written-off are claimed to be deductible is s 8-1. That sub-section provides:

  • "(1) You can deduct from your assessable income any loss or outgoing to the extent that:
    • (a) it is incurred in gaining or producing your assessable income; or
    • (b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.
  • (2) However, you cannot deduct a loss or outgoing under this section to the extent that:
    • (a) it is a loss or outgoing of capital, or of a capital nature; or
    • (b) it is a loss or outgoing of a private or domestic nature; or
    • (c) it is incurred in relation to gaining or producing your exempt income or your non assessable non exempt income; or
    • (d) a provision of this Act prevents you from deducting it.
  • (3) A loss or outgoing that you can deduct under this section is called a general deduction ."

82. It is convenient to consider separately the facts and contentions relevant to the bad debt written-off by each of the taxpayer entities identified in the table reproduced at [0] above.

(ii) EFGA's bad debt deductions

(a) The ELFIC/EFGA Bad Debt Deduction

83. EFGA claimed a deduction of $1,202,441,115 for the whole of the amount of debts due to it from ELFIC written off in the calculation of EFGA's taxable income for the 1998 year (the "ELFIC/EFGA Bad Debt Deduction"). Of the ELFIC/EFGA Bad Debt Deduction claimed by EFGA;

Deductions for these debts written off as bad were claimed pursuant to either s 25-35(1)(a) or (b) or s 8-1 of the 1997 Act.

84. It was submitted on behalf of EFGA that the outstanding loans which gave rise to the ELFIC/EFGA Bad Debt Deduction had been advanced by EFGA to ELFIC to facilitate and enhance collection of loans which had been made earlier by EFGA to ELFIC in the ordinary course of EFGA's business of lending money, and that, accordingly, the loss or outgoing incurred by writing off the amount of $1,202,441,115 was a loss or outgoing incurred by EFGA in the course of a business for the purpose of deriving assessable income.

(b) The EFGS/EFGA Bad Debt Deduction

85. As at 30 June 1998, EFGS owed EFGA debts totalling $106,009,231. On 19 June 1998, the $100,009,231 that EFGS could not pay or repay to EFGA was written off as bad, and the interest rate on the debts reduced by the Board of EFGA to nil per cent per annum with effect from 30 June 1998.

86. EFGA claimed a deduction of $100,009,231 for the whole of the amount written off in the calculation of its taxable income for the 1998 year (the "EFGS/EFGA Bad Debt Deduction"). Of the EFGS/EFGA Bad Debt Deduction claimed by EFGA:

87. It was submitted that the outstanding loans which gave rise to the EFGS/EFGA Bad Debt Deduction had been advanced by EFGA to EFGS to facilitate and enhance collection of loans made earlier by EFGA to EFGS in the ordinary course of, EFGA's business of lending money, and that, accordingly, the loss or outgoing incurred by writing off the amount of $100,009,231 was a loss or outgoing incurred by EFGA in the course of a business for the purpose of deriving assessable income.

88. Seven of the companies in the Foster's Group claimed to have incurred tax losses in various tax years from 1996 to 1999 as a result of the transactions detailed in [0], [0] and [0] above. Those claimed losses can also be illustrated in tabular form as follows:

Loss company Income year Amount of loss
FGL 1998 $119,899,125
EFGT 1998 $525,437,631
Amayana 1999 $134,238,640
EFGA 1998 $1,299,477,144
ELFIC 1997 $87,255,934
EFGS 1996 $7,560,282

ATC 10375

(c) The Commissioner's contentions in respect of the bad debts written off by EFGA

89. The quantification of the debts owing to EFGA from ELFIC and EFGS was arrived at by applying all payments which had been received from each debtor entity in reduction of the oldest debt then due from that entity. In other words, a principle of "first-in, first-out" ("FIFO") was applied except for the financial years ending 30 June 1992 and 30 June 1993 when it appears that payments received from the debtor entities were applied in reduction of their respective liabilities for interest. It has been contended on behalf of the Commissioner that no part of the principal component of each debt written off by EFGA had been advanced before 1 January 1990.

90. It is said to flow from that proposition that all advances of principal from EFGA to ELFIC and EFGS, having been made after 1 January 1990, had been made after the Finance Group had ceased trading normally and while it was in the process of an "orderly realisation of assets." Accordingly, it was said on behalf of the Commissioner that the deductibility of the advances of principal by EFGA to each of ELFIC and EFGS after 1 January 1990 turns on whether those advances were made in the ordinary course of a business of lending money conducted by EFGA which is the test erected by s 25-35(1) of the 1997 Act.

91. The application of the test suggested on behalf of the Commissioner is said to raise three questions;

(i) EFGA's business before 1 January 1990

92. I am satisfied that, in performing its "treasury functions" for the Finance Group between 1986 and the end of 1989, EFGA operated analogously to a bank. It borrowed money from a variety of sources outside the Finance Group and on-lent the money so borrowed to ELFIC and EFGS (amongst others) at interest. It also lent money to external borrowers on the short term money market which was not immediately required to be deployed within the Foster's Group. As well, it accepted on deposit from entities within the Foster's Group, including ELFIC and EFGS, moneys which were surplus to the immediate business needs of those entities. It was acknowledged on behalf of the Commissioner that EFGA's activities in conducting a treasury operation were intended to yield a profit, but that intention, it was said, had to be evaluated in the context of EFGA's essential function which was to obtain debt funding "in a centralised fashion" for the benefit of other companies in the Finance Group which were themselves to carry on businesses of lending money.

93. Counsel for the Commissioner emphasised evidence in the form of contemporary documents dating from October 1984 including Board papers, statements of objectives, EFGA's operating charters and a request for stamp duty exemptions which make clear that the primary function of the company which became EFGA was conceived to be its establishment in the financial markets as a substantial centralised borrowing unit which could raise borrowed funds more cheaply and efficiently than individual entities within the Foster's Group. Another advantage of the interposition of a central treasury between operating entities of the Foster's Group and the sources of borrowed funds was seen to be the elimination of competition for funds between those entities in the external money market. It was considered that the benefit of the resultant savings could then be passed on to operating companies within the Foster's Group which would be on-lending to external customers the funds passed from the centralised borrowing unit, EFGA.

94. The Commissioner placed considerable emphasis on the fact that the margin above the cost to EFGA of externally borrowed funds which EFGA charged the operating entities, including ELFIC and EFGS, was "negligible" - of the order of 0.60%, which prompted certain executives in charge of the central treasury to express views to the effect that it

ATC 10376

was "illusory" to suggest that funding of internal entities made a profit for EFGA. Similar views were expressed to the effect that "funding" would always lose money. Reference was made additionally, in the same context, to the absence of any separate accounting within EFGA of the income derived from on-lending within the Foster's Group as distinct from the income derived from loans on the short-term money market to external parties. Although management accounts and budgets showed the difference between the cost of funds and interest earned from on-lending those funds, that difference was negligible in amount having regard to the "massive" sums which were on-lent to the internal entities. As well, the Commissioner pointed to the absence of any allowance in the management accounts or budgets by way of provision for bad or doubtful debts or otherwise in respect of the risk of non-repayment by one or other of the internal entities and the failure to attempt any "rigorous measurement" of EFGA's revenue relative to its expenses.

95. A related consideration was said to be the fact that EFGA's massive on-lending to ELFIC and EFGS between 1987 and 1989 was maintained in the face of slender and diminishing ratios of assets to liabilities of each of those members of the Foster's Group. It was no answer to that consideration, the Commissioner argued, that any inability by ELFIC or EFGS to repay principal or pay interest on borrowed funds could be rectified by an injection of capital by EFGA.

96. Counsel for the Commissioner also contended that the evidence suggested that the primary function of the attribution or identification of a "profit" within the management accounts of EFGA was as a crude measurement of performance by treasury staff and a basis for rewarding them with bonuses.

97. The Commissioner contrasted the "unbusinesslike" approach of EFGA to loans to ELFIC and EFGS as internal entities with the controls and protocols imposed on the lending by those companies to external customers. It was suggested that no prudential limits, terms of lending or security requirement were imposed in respect of loans by EFGA to entities within the Foster's Group so as to reflect the borrowers' "weak and deteriorating balance sheets." Also indicative of a similar lack of businesslike concern with the risk of lending was said to be the absence of any adjustment from time to time of the rate of interest charged to internal borrowers by reference to the degree of risk. Rather, the rate was set by agreement between EFGA and the borrowing entity having regard to the rate at which the borrower would, itself, have been able to obtain funds on the open market.

98. It was also pointed out on behalf of the Commissioner that the margin of 0.60% charged to internal borrowers within the Foster's Group was not a mark-up or margin on top of the cost to EFGA of the borrowed funds. Rather, it was added to the 90-day BBR and represented, after allowing for expenses, only a minuscule total addition to the amounts advanced. It represented, on the Commissioner's case, no more than a "break-even" target or even less when account was taken of the revenue derived by EFGA from loans to non-related parties. These factors, in combination, were said to provide a strong contra-indication of engagement by EFGA in a "business of lending money."

99. EFGA's involvement in making loans to external borrowers on the short-term money market was said not to be available to support its engagement in a business of lending money because that activity was purely ancillary to the making of loans to entities within the Foster's Group. It would not have occurred but for EFGA's central treasury function and was part of active management, in the role of an arbitrageur, of borrowing and interest rate fluctuations.

(ii) Did EFGA conduct a business of lending money during the wind-up period?

100. In pressing for a negative answer to this alternative question, the Commissioner pointed to the fact that all of the principal advanced, and interest charged to ELFIC, which was written off as a bad debt by EFGA, had been advanced after 30 June 1990. A similar conclusion was available in respect of most of the principal and interest payable by EFGS which had been written off.

101. After June 1990, EFGA radically changed the nature of its business. It ceased to

ATC 10377

borrow funds from external lenders and looked, instead, to lenders within the Foster's Group. It conducted its activities through RAMCO for the benefit of the Foster's Group as a whole, rather than of EFGA's own business. Consistently with that change, it ceased lending to make a profit. That was done by eliminating, from 1 September 1990, the inter-entity interest rate margin, including that charged to ELFIC and EFGS. The Finance Group's treasury business, other than the funding of internal entities, was sold on 31 January 1990 to the Dresdner Bank. That change of course by EFGA was said to be consistent with an announcement by the Foster's Group, on 8 March 1990, that it would concentrate on its brewing business and divest itself of all its other businesses. From then on, EFGA focused on selling assets and recovering loans which it had made to external borrowers. Although EFGA's assets had been reduced from $5.9 billion at 30 June 1989 to $2.7 billion at 30 June 1990, its assets realisation program was slowed by the deepening recession to a point where it was estimated, in February 1992, as likely to take from five to seven years to complete. Part of that projection reflected a decision to maximise the value of certain real properties which had been acquired from the Emanuel Group by re-zoning and developing the land which was recognised as requiring to be done over an extended time.

102. Although new loans were made during the wind-up period by EFGA to internal borrowing entities, they were made to enable those entities to continue to meet obligations to external third parties from which a discharge could not be negotiated or to enhance the borrowing entities' prospects of recovering debts from third parties.

103. RAMCO's activities during the wind-up period were conducted for the benefit of the Foster's Group as a whole and not solely for the benefit of EFGA. This was illustrated by RAMCO's assumption of management of the Lensworth Group and the establishment of Lensworth Group Limited as a direct subsidiary of FGL rather than as a subsidiary of EFGA.

104. In contending that the loans to ELFIC and EFGS were not made in the ordinary course of EFGA's business of lending money, the Commissioner submitted that the loans were not advanced "with a view to making any real economic return" or "commercial profit" from the internal borrowers. Rather, they were made as a cheap and efficient provision of funds to the borrowing entities which, themselves, carried on businesses of lending money. EFGA's placement of surplus funds on the short-term money market was characterised as "minimising liquidity risk" and "hedging against interest rate and foreign exchange risks."

105. It followed, according to the Commissioner, that the loans to ELFIC and EFGS had been made as part of a commercial activity of EFGA which was not a discrete business of lending money. When EFGA's activities are analysed in the way required by
Fairway Estates Pty Ltd v Federal Commissioner of Taxation 70 ATC 4061; (1970) 123 CLR 153, there could not be imputed to EFGA an intention to carry on the business of lending money along with other activities. In Fairway Estates, Barwick CJ observed, at 163;

"The appellant was incorporated to carry on the business of the lending of money along with other activities. This, I am satisfied was an actual intention of its subscribers and not merely a precautionary inclusion of an object in its memorandum along with a large number of other possible courses of action. The appellant's association with United, having regard to the activities and financial resources of that company, confirms the view that the appellant intended throughout to carry on the business of the lending of money as opportunity offered."

106. The absence of any such intention by those responsible for the incorporation and management of EFGA was said to be confirmed by the concentration in public statements on its role as a large and credible borrower in the global money market and its focus on efficient management of the Foster's Group's exposure to liquidity, currency and interest rate fluctuations. There was no express reference in the various operating charters formulated for EFGA to its carrying on a business of lending money. Nor did EFGA exhibit the systematic and continuous conduct of a commercial activity "capable of being described as, in

ATC 10378

effect, business operations intended to yield a profit"; see
Richard Walter Pty Ltd v Commissioner of Taxation (1995) 95 ATC 4440 per Tamberlin J at 4458.

107. The Commissioner also pointed to the fact that EFGA had a relatively low level of equity of its own and derived its borrowing capacity from its position as the holding company of the Finance Group supported by cross-guarantees from companies within the Group and from the ultimate parent company. As well, the Commissioner relied on what was said to be a lack of relevant skills and expertise among EFGA's executives in the conduct of a business of lending money. Those qualifications were argued to include experience and capacity in assessing the creditworthiness of borrowers and in managing the risks of a portfolio of loans. The skills of the relevant personnel was said to be confined to the performance of treasury functions. In a related way, the Commissioner instanced the absence of limits on lending to a particular internal entity, of the assessment of creditworthiness of the borrowers and of the application of other techniques of risk management. Those features were explained as reflecting the fact that EFGA made its loans to internal entities at the direction of FGL, "the ultimate holding company of the wider Foster's Group."

108. Those features of the arrangements between EFGA and the internal borrowing entities were said to be similar to those in
Hungier v Grace (1972) 127 CLR 210 where the borrower proposed the period of the loan and the rate which, irrespective of that period, was to be paid by way of interest. As to those arrangements, Walsh J said, at 225;

"…seem[] to me to be so greatly at variance with the manner in which I should expect a person to carry on a business of money-lending that it becomes very difficult to affirm that the appellant was carrying on that business."

109. The Commissioner reiterated that the margin charged by EFGA to internal borrowing entities did not reflect the cost from time to time of borrowed funds but was a fixed percentage above the BBR from time to time. It did not reflect any appreciation of the risk of non-repayment and was not charged at all after 1 January 1990. The funding provided by EFGA to, amongst others, ELFIC and EFGS, although nominally at call, was committed indefinitely and its repayment depended on the recovery by the borrowing entities of advances made to their external customers. EFGA had no discretion to advance loan funds to internal borrowers or to withhold them. The risk of non-repayment was entirely assumed by internal borrowers like ELFIC and EFGS.

110. According to the Commissioner, the placement of money on the short-term money market was purely ancillary to its activities as a central treasury and did not qualify EFGA as a participant in a separate business of lending money. In that sense, the observations of Hill J in
Kidston Goldmines Ltd v Commissioner of Taxation 91 ATC 4538; (1991) 30 FCR 77 were said to be applicable to EFGA's participation as a lender in the external money market. In that case, his Honour said, at 80;

"It is clear that the applicant carried on one business, and one only, that is to say a business of goldmining. Its activities of putting out money on the short-term money market were an adjunct to this goldmining business, and not of themselves a separate business activity."

(iii) Did the change in the nature and focus of EFGA's activities after 1 January 1990 amount to ceasing to conduct a business of lending money?

111. As noted at [0] and [0] above, the foreign exchange and currency options business formerly carried on by EFGA apparently through its subsidiary EFGT was sold to the Dresdner Bank on 31 January 1990. That was part of a sell-down, between 1990 and 1998, of all the Foster's Group non-brewing businesses and coincided with EFGA's ceasing, in early 1990, to place funds with external borrowers in the short-term money market. Thereafter, the continued lending of money to ELFIC and EFGS at no cost to those entities was simply a deployment of assets within the Foster's Group to facilitate an orderly realisation or divestment of assets and a concentration on its core business of brewing. In that sense, the following observations of Menzies J in
Franklin's Selfserve Pty Ltd v Federal Commissioner of Taxation 70 ATC 4079; (1970) 125 CLR 52

ATC 10379

, at 67 could be applied to EFGA's internal lending after 1 January 1990;

"… It was an isolated transaction of a very special character undertaken at the behest of the company to which it was a subsidiary and the debt which arose is not to be regarded as occurring in the conduct of any money-lending business in which the taxpayer was otherwise engaged by virtue of its taking mortgages from purchasers. It seems to me that the loss of the principal sum …, or any part of that sum, was not a revenue loss; it was a loss of capital … …"

See also
Northern Engineering Pty Ltd v Federal Commissioner of Taxation 80 ATC 4025; (1979) 42 FLR 301, where Brennan J observed, at 304;

"The depositing or leaving of the appellant's funds with the holding company appears merely to have been a mode of keeping, not of employing, its assets. Merely to preserve assets is not, at least in the circumstances of this case, to carry on a business. There is nothing to show that the activities of the appellant went beyond the keeping of the net assets with which it was left when its only business, the wholesale trading business, came to an end."

112. A variation on the theme of the Commissioner's argument in this context was the contention that, if, contrary to his primary submission, EFGA did carry on a business of lending money during the relevant period, none of the debts due from the subsidiaries was in respect of money lent during the ordinary course of that business. In support of this contention, the Commissioner pointed to aspects of EFGA's activities on which he had relied in support of earlier, related, arguments. Particular emphasis was placed on EFGA's apparent absence of independent judgment as to whether or not to advance the loans or whether, or when, to call them in. It was also contended that EFGA was unconcerned with making an "economic profit" from the internal loans or with how repayments, when made, were allocated. These features of EFGA's activities, the Commissioner suggested, reflected the making of the loans at the direction of FGL solely to fund the subsidiaries in the most economical way. In other words, the continuing funding of ELFIC and EFGS after January 1990 was solely to prevent the financial failure of the Foster's Group as a whole and was not made to effect any business purpose of EFGA.

(d) EFGA's contentions as to its bad debt deductions

113. It was submitted on behalf of EFGA that the debts owed to EFGA by ELFIC and EFGS which had been written off were deductible under s 25-35(1) of the 1997 Act. According to that submission, the moneys had actually been advanced with the intention that principal would be repaid and interest would accrue and be paid. Moreover, such repayments and payments were actually made but not to the full extent of the principal advanced and interest accrued.

114. In relation to the requirement imposed by s 25-35(1)(b) of the 1997 Act, it was contended on behalf of EFGA that it had, between 1986 and 1998, carried on a substantial business of lending money. The nature of that business did not materially change during the "wind down" or orderly realisation of the assets of the Finance Group. Even during that period, EFGA continued to make new advances as well as receiving repayments of principal and payments of interest in respect of existing loans.

115. The debts from ELFIC and EFGS which had been written off were in respect of advances made to those companies before and after March 1990.

116. It was submitted, in the alternative, on behalf of EFGA that the principal and interest components of the debts which had been written off were deductible under s 8-1 of the 1997 Act. It was said that the debts which had been written off were a product of the carrying on of EFGA's business of borrowing and lending and the loans which gave rise to the bad debts were part of a collection of such funds which had been used to produce assessable income. Neither the principal nor the interest component of the relevant bad debts, according to EFGA, had constituted a loss of capital or of a capital nature. Rather, the loan funds were "circulating capital" in the sense used by Kitto J in
National Bank of Australasia Ltd v Federal Commissioner of Taxation 69 ATC 4042; (1969) 118 CLR 529

ATC 10380

, at 537 so that the loss was on revenue account.

117. Counsel for EFGA contended, in the further alternative, that, if the interest and principal written off as bad debts were not wholly deductible, at least the interest component of each such debt was deductible under either s 8-1 or s 25-35(1). The latter sub-section was said to be applicable to the interest component of each bad debt because the interest had been returned as part of EFGA's assessable income in a previous year.

(e) Consideration of EFGA's bad debt deductions

118. I am satisfied that EFGA was before 1990 engaged in a business of lending money. By 1986 it had assumed the treasury function for the Finance Group and as part of that function made very large loans to ELFIC and EFGS. Also, a function ancillary to the making of loans of that kind, it borrowed from external lenders and managed its liquidity by lending or depositing surplus funds on the external short-term money market.

119. Of particular significance is the fact that it lent to internal borrowers like ELFIC and EFGS at a margin above the cost of funds to it which was designed to return a "profit". The prescription of the rate of expected profit by other entities within the Foster's Group which meant that it did not necessarily represent EFGA's assessment from time to time of what the market would bear, does not detract from the fact that EFGA's activities were carried on with a degree of system and continuity or repetition which a Full Court of this Court in
Commissioner of Taxation v Bivona Pty Ltd 90 ATC 4168; (1990) 21 FCR 562, citing
Edgelow v MacElwee [1918] 1 KB 205, at 206, regarded as an indication of the carrying on of a principal business of lending money.

120. Nor do I regard it as critical that almost all of the loans by EFGA were made to other subsidiaries of the Foster's Group. As Tamberlin J observed in a similar context in
Richard Walter Pty Ltd v Federal Commissioner of Taxation, supra, at 4,458:

"I think it is artificial in the circumstances of the present case to draw a distinction between the loans made to members of the group and loans to other persons or bodies."

121. Similarly, I do not regard as significant in characterising the ordinary course of EFGA's business the fact that benefits other than the derivation of a profit were perceived as likely to flow from the conduct of that business. The failure to make provision in EFGA's accounts for bad or doubtful debts owed by borrowers within the Foster's Group was explicable by the common enterprise in which the Group was engaged and the fact that there were no separate shareholders who might look to individual subsidiaries, including EFGA, for a dividend. Similar considerations explain the maintenance between 1987 and 1989 of high levels of advances to ELFIC and EFGS notwithstanding the diminishing individual creditworthiness of those subsidiaries.

122. It is not to the point, in my view, that an activity has been carried on in an "unbusinesslike" or inefficient manner. The distinction as McCardie J suggested in
Edgelow v MacElwee, supra, at 206 is between loans to relations, friends or acquaintances or otherwise on an occasional and disconnected basis and loans made with the requisite degree of system and continuity to import the carrying on of a business. On this analysis, I have concluded that EFGA before 1990 lent money to ELFIC and EFGS in the ordinary course of EFGA's business of lending money.

123. Nor have I been able to conclude that the activities of EFGA during the wind-up period were otherwise than in the ordinary course of its business of lending money. It is true that during that period EFGA ceased to charge the previous inter-entity rate of interest on loans to Finance Group borrowers but that was merely in recognition of the precarious financial states of those subsidiaries and the need for EFGA to make its own contribution to a quick and effective realisation of group assets. There was, I consider, an actual and continuing intention by those managing EFGA to carry on during the wind-up period its business of lending money although the carrying on of the same business was directed to a different end or purpose. In that sense the intention of those controlling EFGA during the wind-up period coincided with that regarded by Barwick CJ in
Faraway Estates Pty Ltd v Federal Commissioner of Taxation (1970), supra, at 163, as satisfying the relevant test.

124.

ATC 10381

That EFGA carried on its activities during the wind-up period at the direction of others, including, ultimately, FGL does not entail that it ceased during that period to carry on its former business of lending money. It was merely directed to carry on the same business for different purposes which included the winding up of its own business at the core of which was the lending of money, the recovery of principal advanced and accrued interest thereon. The leaving of funds with ELFIC and EFGS was still a mode of employing those assets in the sense suggested by Brennan J in
Northern Engineering Pty Ltd v Federal Commissioner of Taxation 80 ATC 4025; (1979) 42 FLR 301, at 304. The employment during the wind-up period of funds advanced to ELFIC and EFGS was not profitable for EFGA as it had been before 1990 but that does not entail that a change occurred in the character of the business pursuant to which the funds had been advanced. Nor, contrary to the Commissioner's submission, did it entail that the loans to ELFIC and EFGS after 1990 were no longer advanced in the ordinary course of lending money.

125. For these reasons I have been led to conclude that the principal and interest owed to EFGA by ELFIC and EFGS which had been written off were deductible under s 25-35(1) of the 1997 Act. I am reinforced in that conclusion by the fact that, throughout the relationship of creditor and debtor, moneys were actually advanced to ELFIC and EFGS and in part repaid by them together accrued interest, albeit not the full amount of such interest.

126. In light of the conclusions which I have just reached, it is unnecessary to consider the alternative submission advanced on behalf of EFGA, that the debts owed by ELFIC and EFGS which were written off as bad were wholly or partly deductible under s 8-1 of the 1997 Act.

(iii) EFGT's bad debt deductions

127. EFGT's claimed deduction included a debt of $525,260.13 representing unpaid interest written off as bad which had been owed to it by EFGA. Submissions similar to those for EFGA were advanced in support of this claim to a deduction by EFGT. The bad debts were said to be deductible under s 25-35(1)(a) or, alternatively, under s 8-1 of the 1997 Act.

128. It will be recalled that EFGT became the conduit for loan funds provided under a Security Note by the Foster's Group to EFGA as part of the security structure erected in 1991 as described at [0] of these reasons. The loans from EFGT to EFGA were made at interest and EFGT in turn paid interest under the Security Note facility at a rate of 1.5% above the 90 day BBR. Further advances were made by the Foster's Group to EFGT after October 1991 and a further Security Note for $0.5 billion was executed in respect of those further advances in August 1992. The further funds were on-lent by EFGT to EFGA which continued to be charged interest to the end of the 1998 financial year. EFGT similarly continued to be charged interest during the same period on the further funds advanced to it by the Foster's Group. EFGT also accepted, in addition to the funds borrowed under the security structure, moneys on deposit from other members of the Finance Group and incurred a liability for interest on those deposits. In each year from 1993, except 1996 and 1997, EFGT made substantial operating profits from its activities. However, in 1996, it recorded a massive operating loss of $1,119,511,434 and in the following year a smaller, but still significant, operating loss of $1,284,849. In the same period its total reported expenditure by way of interest was almost identical in each year to its reported income in the form of interest. The greater part of that interest in each year appears to have been incurred on borrowings from FGL.

129. In opposing EFGT's claim to a deduction to the bad debt written off in respect of the interest due from EFGA, the Commissioner relied on the submissions, so far as applicable, which he had advanced in respect of the claim by EFGA for a bad debts deduction. He also relied generally on certain factual conclusions that were said to be available in relation to the capacity of ELFIC, EFGS, EFGA, EFGT and Amayana to pay interest and principal on their inter-company loans. In the first place, it was pointed out that each of the loans was repayable at call. As indicative of the straitened circumstances of companies within the Finance Group, the Commissioner pointed to the fact that, in May

ATC 10382

and June 1990, the directors of the Finance Group had sought a letter of comfort from FGL and had only been prepared to sign the solvency statements in the statutory accounts of members of the Finance Group after FGL, on 20 June 1990, passed a resolution that FGL would support the subsidiaries. A letter dated 6 July 1990 from BHP was said to indicate a belief by that company that loans by FGL to Finance Group subsidiaries would be repaid.

130. Other indications from the evidence were relied on as tending to establish that, during 1990, EFGA, EFGS and ELFIC had, or were likely to have, a net deficiency of assets and from 31 December 1990, EFGA "had begun to suffer a deficit" of $13 million in shareholders' funds. One of the consequences was that Amayana would not be able fully to recover its receivables from EFGA.

131. The Commissioner also relied heavily on a report by Mr Meredith, a financial analyst, who demonstrated that, in the year ended 30 June 1990, ELFIC's available assets totalled $522 million whereas its liability to EFGA in respect of principal and interest amounted to $992 million. The discrepancy widened in subsequent years to a point where, by 30 June 1997, ELFIC had no available assets from which to make repayments. A similar deteriorating pattern of incapacity to pay obtained in respect of EFGS. In consequence, by 30 June 1997, EFGA's capacity to repay principal and interest on loans to it from Amayana had been reduced to 11% of the total liability.

132. Mr Meredith's approach to assessing EFGA's capacity to pay was defended by the Commissioner as reflecting realistic prospects of recovering loans from subsidiaries as discernible from their statutory accounts rather than having regard to provisions made by EFGA for loans which were not fully recoverable. Those provisions were characterised by the Commissioner as mere "balancing items" which provided no true guide to the recoverability of loans made by EFGA to ELFIC and EFGS.

133. Counsel for the Commissioner also discounted the applicants' contention that Mr Meredith's approach failed to take account of the possibility that assets disclosed by the statutory accounts might be realised for more than their book values. It was pointed out that the assets comprised loans of fixed amounts and, in any event, were realisable for the benefit of FGL rather than the Finance Group.

134. Another issue raised by Mr Meredith's evidence centred on his assumption that two loans to EFGA by internal entities, EFGT and Amayana, ranked equally. Although EFGT held security over EFGA's assets and Amayana did not, the Commissioner contended that the security granted to EFGT was merely a device to defeat external creditors. In support of this contention, the Commissioner instanced the fact that FGL did not exercise its powers under a charge from ELFIC despite the occurrence of a "trigger" event, namely ELFIC's having become unable to pay its debts as and when they fell due. The Commissioner also pointed to EFGA's having made repayments under the loan to it from Amayana despite the fact that the much larger loan from EFGT remained outstanding.

135. In further reliance on Mr Meredith's evidence, the Commissioner claimed that, between July 1990 and July 1998, Amayana lacked the capacity to repay in full money which it had borrowed from FBGTA and on-lent to EFGA. Over the period in question, on Mr Meredith's analysis, Amayana's capacity to meet its liability to FBGTA had declined from 41% of the loan balance to only 11%. A similar analysis led Mr Meredith to conclude that, between 1992 and the financial year ending on 30 June 1996, EFGT's capacity to repay to FGL moneys which EFGT had on-lent to EFGA had declined from about 25% to a mere 1%. The difference between Mr Meredith's analysis and the statutory accounts of Amayana and EFGT, according to the Commissioner, was explicable by the fact that EFGT did not raise provisions against its assets until the financial year ended 30 June 1996 when it raised a provision of $1,120,000,000 and Amayana never raised such a provision but allowed its net assets to be recorded as represented by its paid-up capital of $2.

136.

ATC 10383

In the light of the matters to which he drew attention, the Commissioner invited the conclusion that, from early to mid 1990, the Finance Group was unable to pay its debts as and when they fell due and that, without FGL's support, external lenders would have refused further credit and have begun calling up existing debt as it became enforceable, thereby forcing the companies in the Finance Group into liquidation.

137. On the Commissioner's analysis, the "real loss" between 1991 and 1998 was incurred by ELFIC and EFGS when loans which they had made in the course of their respective money lending businesses proved irrecoverable. As a result, ELFIC and EFGS were unable to pay interest or repay capital on loans made directly or indirectly to them by other companies within the Foster's Group. This inability was at all times known to those directing the affairs of the Foster's Group who, nevertheless, continued, until 1998, to make inter-group loans and to allow accrued interest to be capitalised.

138. The Commissioner also claimed that the "tax loss", presumably of the Foster's Group as a whole, had been "magnified" because each company in the funding chain had been able to write-off amounts for internally generated debts in the form of interest which had not been paid. That "magnifying" effect was also said to have been compounded by the delay, until 1998, in writing off the debts and ceasing to debit the borrowing companies with further instalments of interest.

139. On the assumption that each relevant taxpayer had not been carrying on a business of lending money, the Commissioner disputed that s 25-35(1)(a) of the 1997 Act had any application to the debts in respect of unpaid interest. That provision, it will be recalled, is in these terms;

"You can deduct a debt (or part of a debt) that you write off as bad in the income year if:

  • (a) it was included in your assessable income for the income year or for an earlier income year."

140. Two reasons were advanced by the Commissioner against the deductibility under s 25-35(1)(a) of the write-offs in question. In the first place, it was contended that there was no reasonable prospect that the interest returned as assessable income by creditor companies would be received. That was because EFGA lacked capacity to pay interest from time to time because of the inability of ELFIC and EFGS to recover enough under the loans due to them to reimburse EFGA in respect of advances respectively made to ELFIC and EFGS. In this context, the Commissioner relied on
Permanent Trustee Co (Executors of F H Prior dec) v Federal Commissioner of Taxation (1940) 6 ATD 5,
Cross (Inspector of Taxes) v London & Provincial Trust Ltd [1938] 1 KB 792 and
Henderson v Federal Commissioner of Taxation (1969) 119 CLR 612 per Windeyer J, at 637.

141. The second proposition on which the Commissioner relied in this context was that interest recognised as having accrued is not derived for tax purposes until it has been received. In the present case, there was no "coming home" or "coming in" to the taxpayer in a realisable form of an amount representing interest on the loans in question; cp,
The Commissioner of Taxation (SA) v The Executor Trustee and Agency Company of SA Limited (1938) 63 CLR 108 and
St Lucia Usines & Estates Co Ltd v Colonial Treasurer of St Lucia [1924] AC 508, at 512.

142. The Commissioner accepted that taxpayers who carry on a business of lending money are excepted from the general rule that interest is only assessable when received and are obliged to return interest as income as it accrues. However, this exception was said to be available, even arguably, only to EFGA which, for the reasons summarised at [0]-[0] above, was not engaged in a business of lending money. It followed, according to the Commissioner, that it is not open to a taxpayer to invoke s 25-35(1)(a) in consequence of a mistaken return of interest as income in a given year. An assessment giving effect to a mistaken return of that kind in a given year should be amended and any claim to write off as a bad debt the interest so returned should be disallowed.

143. An alternative contention advanced on behalf of the Commissioner was that the amount of the deduction available under s 8-1

ATC 10384

of the 1997 Act is limited to the loss suffered by the taxpayer. It was said that the debts in the form of unpaid interest written off by EFGA, EFGT and FGL as at 30 June 1998 and by Amayana in July 1998, did not give rise to any loss for the purposes of s 8-1 because the receivables were valueless when brought to account. Support for this proposition was said to be derived from
J Rowe & Son Pty Ltd v Federal Commissioner of Taxation 71 ATC 4157; (1970-71) 124 CLR 421 and
BHP Billiton Petroleum (Bass Strait) Pty Ltd v Commissioner of Taxation 2002 ATC 5169; (2002) 126 FCR 119, at 140 [80]. In a related way it was argued that the creditor companies did not incur the losses in gaining or producing income because there was never a realistic prospect of receiving more than a negligible amount of the interest accruing from time to time. Any payment of interest would have affected detrimentally the ability of the debtor companies to make repayments of capital.

144. A further alternative argument advanced on behalf of the Commissioner was that, if the creditor companies did suffer losses to the extent of the bad debts written off, those losses were of a capital nature and not allowable under s 8-2 of the 1997 Act. The losses were unrelated to the income-producing activities of any of FGL, EFGT, Amayana or EFGA because each advance was made after the relevant borrowing entity had become insolvent. The loans were made to ensure the survival of companies in the Finance Group and ensure the orderly realisation of the assets of those companies, thereby preventing the failure of the Foster's Group as a whole. There was never any prospect that the debtor companies would pay interest or dividends. Reference was made to
North Australia Pastoral Co Ltd v Federal Commissioner of Taxation (1944) 71 CLR 623, at 635 and
Odhams Press v Cook [1940] 3 All ER 15, and a comparison was invited with
Federal Commissioner of Taxation v Total Holdings (Aust) Pty Ltd 79 ATC 4279; (1979) 24 ALR 401.

Consideration of EFGT's bad debt deductions

145. For the reasons explained in relation to EFGA, I have concluded that the principal and interest owed to EFGT by EFGA was money lent by EFGT in the ordinary course of its business of lending money. EFGT had itself borrowed that money and incurred interest expenses in doing so. Except in 1996 and 1997, its business of lending money to EFGA and, through it, to other members of the Finance Group had been profitable. The fact that borrower companies found themselves in financial difficulties between 1990 and 1998 does not detract from the conclusion that the continuing provision of debt finance to those companies to enable them to trade out of their difficulties was in the ordinary course of a business of lending money.

146. It is true that decisions could have been made earlier than they were to write-off the bad debts in question or to cease to charge interest to the borrowing companies. However, those were matters calling for the exercise of commercial judgment. In the present case that judgment was coloured by a view of the time needed to recover the debts and the extent to which they were recoverable, which proved unduly optimistic. However, the fact with hindsight the decisions which were made can be regarded as ill-advised, cannot affect the deductibility of the debts under s 25-35(1)(b) of the 1997 Act.

147. I do not regard the necessity for several companies within the Foster's Group to have written off bad debts owed by other companies within the Group as having the "magnifying" effect for which the Commissioner contended. Each debt had actually been incurred and each of the relevant debtors had made substantial repayments of principal and payments of interest in respect of its indebtedness. It was therefore available to be written off by the entity in the Foster's Group to which it was owed.

148. The conclusion which I have reached in relation to EFGT's bad debt deductions makes it unnecessary to consider, in respect of that taxpayer, the Commissioner's further contentions about the application to that taxpayer of s 25-35(1)(a) or s 8-1 of the 1997 Act.

ATC 10385

(iv) FGL's bad debt deductions

149. The Commissioner disallowed a deduction claimed by FGL in respect of the 1998 year of income for bad debts written off in that year and constituted by unpaid interest and outstanding principal referable to loans made by FGL to EFGT. The bad debts written off totalled $634,220,249 of which the interest component had been included in FGL's assessable income in each year in which interest had accrued. The accounts of the consolidated Foster's Group of which FGL was the listed parent company reveal that FGL and the consolidated Foster's Group made substantial operating profits in each year from 1989 to 1998 except for 1992 when FGL had an operating loss of $949,439,000 and the consolidated Foster's Group had an operating loss of $949,385,000. FGL's operating revenues over the same period included in each year a significant component of interest which was returned in FGL's assessable income.

150. Initially, intra-group loans were made by FGL at interest directly and indirectly to EFGA. The indirect loans were made by way of advances to AML Finance which were then on-lent to EFGA. After the erection of the security structure noted at [0] above, AML Finance's loans to EFGA were replaced by loans from FGL to EFGT and thence to EFGA. Those loans continued to accrue interest which, from that time, was at the 90 day BBR plus 1.5%.

151. EFGT made substantial payments of interest and repayments of principal to FGL between 1992 and 1998. It also made further such payments in excess of $61 million between 1999 and 2001.

152. The Commissioner impliedly accepted that FGL had never carried on a business of lending money and otherwise relied on the contentions which I have already summarised as denying the deductibility under either s 25-35(1)(a) or s 8-1 of the 1997 Act of the bad debts written off by FGL.

153. In respect of FGL's claim for the bad debt deductions, Counsel for the taxpayers advanced submissions essentially similar to those addressed to the corresponding claim for a deduction by EFGA. However, as an alternative to a claim for the deduction under s 25-35(1)(a) of the 1997 Act for the whole of the debts written off as bad, it was argued that the interest component of those debts was deductible under s 8-1 of the 1997 Act because that component was not capital or of a capital nature;

"The characteristic of the loss or outgoing is determined by the nature of what was written off. The interest arose daily on the outstanding amounts owed to EFGT by EFGA. It follows that the writing off of bad debts in respect of interest was a loss or outgoing of a revenue nature."

Consideration of FGL's bad debt deduction

154. In my view the bad debts written off by FGL in respect of the debts due to it from EFGT were deductible under s 25-35(1)(a) or alternatively under s 801 of the 1997 Act but only to the extent that those debts contained a component representing unpaid interest. It cannot be suggested that FGL was engaged in a business of lending money. Its business, the evidence indicates, was that of a holding company. It is apparently not disputed that it included as part of the assessable income derived from that business in previous years the interest charged to EFGT. The evident policy which I discern as underlying s 25-35(1)(a) is that a taxpayer who returns as income in one year an amount earned or derived but not received, is entitled to deduct from the assessable income for a later year that amount if it is not received but is written-off in the later year. I accept that the mistaken inclusion of an amount as income in an earlier year cannot support a deduction of the amount so included in a later year. As Hill and Heerey JJ observed in
BHP Billiton Petroleum (Bass Strait) Pty Ltd v Commissioner of Taxation 2002 ATC 5169; (2002) 126 FCR 119, at 140 [80];

"Then there is the question whether the taxpayer would be entitled to a deduction under s 63 of the Act should it turn out that the taxpayer was not owed the amount claimed and which has been included in assessable income. Under the law as presently interpreted it would seem that the taxpayer could not. No deduction is available under s 63 if, at the time of write-off, there is actually no debt owed as might be said to be the case in the event that the taxpayer's claim to the invoiced amount was

ATC 10386

unsuccessful:
GE Crane Sales Pty Ltd v Commissioner of Taxation (Cth) (1971) 126 CLR 177,
Point v Commissioner of Taxation (Cth) (1970) 119 CLR 453,
Franklin's Selfserve Pty Ltd v Commissioner of Taxation (Cth) (1970) 125 CLR 52. There might, for the same reason, be no ability of a taxpayer to obtain a deduction under s 51(1) of the Act, because the taxpayer would have incurred no loss if it should turn out that the taxpayer was never owed the amount claimed. While both ss 63 and 51(1) have been repealed and replaced in the Income Tax Assessment Act 1997 (Cth) by ss 25-35 and 8-1 respectively, the problem averted to has not been the subject of legislative intervention."

155. It is for that reason that I consider the deduction claimed by FGL should be confined to the interest component of the debt written off. I am unable to perceive any basis on which the capital amount or principal of any advance by FGL to EFGT could have been correctly included in FGL's assessable income for a previous year. A similar process of reasoning would lead to the loss of principal written off being characterised as "a loss or outgoing of capital or of a capital nature" and so excluded by s 8-2(1) of the 1997 Act from deductibility under s 8-1(b) of that Act.

(v) Amayana's bad debt deductions

156. It was contended on behalf of Amayana that the interest component of the bad debts written off in the 1999 year of income was deductible from Amayana's assessable income for that year under s 25-35(1)(a), or alternatively under s 8-1, of the 1997 Act. In this context, Counsel for Amayana invoked essentially the same contentions as had been advanced on behalf of FGL.

157. The Commissioner relied, in relation to Amayana, on essentially the same contentions as he had advanced against the deductibility of the bad debts written off by EFGA, EFGT and FGL. As with FGL, the Commissioner did not have to meet an argument that the bad debts written off by Amayana had been in respect of money which it had lent in the ordinary course of a business of lending money. However, the Commissioner also raised an additional argument based on the application to the whole of the debt for principal and interest due to Amayana from EFGT which was written off. According to the Commissioner, neither amount should have been recognised as a receivable in Amayana's accounts and so there was no debt in respect of unpaid interest which could have been written off as bad by Amayana.

158. Alternatively, the Commissioner contended that Div 245 of Sch C of the 1936 Act applied to the whole debt constituted by unpaid principal and interest written off by Amayana. In the result, the loss suffered by EFGA would be reduced by $200,241,963 and that suffered by EFGT by $83,384,542.

159. A "debt" is defined by s 245-15 of Sch 2C as "an enforceable obligation imposed by law on a person to pay an amount." Division 245 characterises a debt as a "commercial debt" if interest payable on it is, or would be, allowed as a deduction to the debtor. If, contrary to the Commissioner's primary contention, it be held that the unpaid interest owed by EFGA to Amayana is deductible, then the debt becomes a "commercial debt" as defined in s 245-25. That commercial debt, the Commissioner contended, was forgiven in the sense that, when it was written-off, it was "released, waived or otherwise extinguished" within the meaning of s 245-35. The Commissioner calculated the "gross forgiven amount" of the debt due from EFGA to Amayana in accordance with s 245-55 as $325,088,518 and because none of the amounts specified in s 245-85(1) was available to reduce the amount of EFGA's debt the net forgiven amount of that debt was said to be $323,678,521.

Consideration of Amayana's bad debt deductions

160. As already noted at [0] above, Amayana's claim to a deduction for bad debts written off was confined to the interest component of those debts. For essentially the same reasons as I have explained in relation to the corresponding claim by FGL, I consider that the deduction, as so confined, should have been allowed. I am satisfied that there were actual debts due from EFGA to Amayana in respect of which substantial repayments of principal and payments of interest were made between 1991 and 1998 and it was therefore appropriate to

ATC 10387

record unpaid interest as a receivable in Amayana's accounts. Moreover, for the reasons explained at [0] below, no part of the debt due from EFGA to Amayana, although it was a commercial debt, was forgiven in the sense described in s 245-25 of Schedule C to the 1936 Act.

The deductibility of interest expenses incurred by borrower companies within the Foster's Group

161. Some of the same members of the Foster's Group and some other members claimed deductions from their taxable income for relevant years in respect of interest on borrowings from other members of the Foster's Group. Those deductions have been illustrated by the following table also furnished as part of the written submissions filed on behalf of the Commissioner;


"Taxpayer Income Year Amount of deduction Borrowings from
EFGT 1998 $47,514,675 FGXL
Amayana 1998 $16,875,354 FBGTA
EFGA 1998 $57,645,096 EFGT
EFGA 1998 $25,036,634 Amayana
ELFIC 1995 $95,293,880 EFGA
ELFIC 1996 $106,399,661 EFGA
ELFIC 1997 $93,156,592 EFGA
EFGS 1997 $6,804,054 EFGA"

162. In urging that those deductions were not available to the respective borrowers, the Commissioner again pointed to the extreme unlikelihood, after 1990, that any of the borrowing companies would be able to pay all, or even most, of the interest on their borrowings. That incapacity, it was said, was self-evident and compelled the conclusion that the earning of interest from the debtor companies was not a genuine concern of those in the Foster's Group involved in managing the affairs of the taxpayer companies. The focus was, rather, on the external assets and the ability of the whole Foster's Group to survive. These inferences were said to be reinforced by a request made of FGL in 1991 for $400 million in interest-free funding for EFGA which, it was recognised, would have "no impact on the liquidity of the Group …. [as] …. all of the entries associated with it would have been eliminated on consolidation." Accordingly, there was no purpose of earning interest on the loans to internal entities.

163. Alternatively, because everything done after March 1990 in relation to those loans was done with a view to preserving the viability of the Foster's Group as a whole, liability for interest incurred at various points in the internal chain should be treated as of capital account.

164. The Commissioner accepted that s 51(1) of the 1936 Act (applicable to the income years ended 30 June 1995, 1996 and 1997) and s 8-1 of the 1997 Act (applicable to the income year ended 30 June 1998) were not materially different in operation or effect. It was pointed out that each of FGL, EFGT, Amayana and EFGA had returned the unpaid interest as assessable income in each income year in question and had claimed as deductions the interest costs incurred in advancing the sums. The result in each case was said to be "tax neutral" until each taxpayer company wrote off as bad debts the amounts of unpaid interest and claimed tax deductions in respect of the amounts so written off.

165.

ATC 10388

ELFIC and EFGS each claimed as deductions the interest expenses which they had incurred on loans from internal creditor companies but, as the Commissioner pointed out, those interest expenses were disproportionately greater than the income which each of ELFIC and EFGS derived from external customers, particularly from 1990 when ELFIC and EFGS were in "wind down mode" with no prospect of meeting their liabilities for interest. This feature of the case was said to attract the application of the principle enunciated in these terms in
Fletcher v Federal Commissioner of Taxation 91 ATC 4950; (1991) 173 CLR 1, at 18-19;

"The position may, however, well be different in a case where no relevant assessable income can be identified or where the relevant assessable income is less than the amount of the outgoing. Even in a case where some assessable income is derived as a result of the outgoing, the disproportion between the detriment of the outgoing and the benefit of the income may give rise to a need to resolve the problem of characterization of the outgoing for the purposes of the sub-section by a weighing of the various aspects of the whole set of circumstances, including direct and indirect objects and advantages which the taxpayer sought in making the outgoing [See, eg,
Robert G Nall Ltd v Federal Commissioner of Taxation (1937), 57 CLR 695, at pp 699-700, 706, 708-709, 712-713]. Where that is so, it is a "commonsense" or "practical" weighing of all the factors which must provide the ultimate answer [[See, eg,
BP Australia Ltd v Federal Commissioner of Taxation (1965), 112 CLR 386, at pp 396-397;
[1966] AC 224, at p 264;
Hallstroms Pty Ltd v Federal Commissioner of Taxation (1946), 72 CLR 634, at p 648;
Federal Commissioner of Taxation v Foxwood (Tolga) Pty Ltd (1981), 147 CLR 278, at pp 285, 293]. If, upon consideration of all those factors, it appears that, notwithstanding the disproportion between outgoing and income, the whole outgoing is properly to be characterized as genuinely and not colourably incurred in gaining or producing assessable income, the entire outgoing will fall within the first limb of s 51(1) unless it is either somehow excluded by the exception of 'outgoings of capital, or of a capital, private or domestic nature' or 'incurred in relation to the gaining or production of exempt income'. If, however, that consideration reveals that the disproportion between outgoing and relevant assessable income is essentially to be explained by reference to the independent pursuit of some other objective and that part only of the outgoing can be characterized by reference to the actual or expected production of assessable income, apportionment of the outgoing between the pursuit of assessable income and the pursuit of that other objective will be necessary."

166. In the case of such a disproportion between outgoings of interest and income derived, the High Court's approach, the Commissioner contended, requires a determination of whether the taxpayer "genuinely incurred the interest in order to gain assessable income or for an ulterior purpose."

167. A different formulation of the same approach was ventured by Gyles J in
Spassked Pty Ltd v Federal Commissioner of Taxation 2003 ATC 4184; (2003) 136 FCR 441 where his Honour observed, at 479-80 [128];

"The same principle does not apply to purely intra-group arrangements with no external aspect. All of the relevant arrangements were between companies with the same beneficial ownership. Many of the companies involved, including Spassked, had no external role at all. The arrangements involving those companies were inherently variable at the will of the ultimate board of directors. They do not reflect the exercise of business judgment in the relevant sense. Thus, the requisite connection or relationship between the outgoing and the earning of assessable income is not to be inferred but must be positively established."

168.

ATC 10389

The same approach, the Commissioner argued, precludes the Court in this case from concluding that the whole of the claims for interest can properly be characterised as "genuinely and not colourably incurred in gaining or producing assessable income." The real purpose of each entity in incurring the relevant interest expense was in preserving the overall financial viability of the Foster's Group as a whole and was focused on its overall assets and liabilities insofar as they might affect the actions of external creditors in relation to FGL as an unsecured creditor of companies within the Finance Group. There was no real concern with income earning activities of "the individual entities involved in the funding structure."

169. It was said in the same context that the charging of interest ultimately for the benefit of FGL allowed it to take full advantage of the dividend rebate on dividends flowing to it from within the Finance Group; cp
Spassked Pty Ltd v Federal Commissioner of Taxation (No 5) 2003 ATC 4184; (2003) 197 ALR 553, at 561-2 [31], [32].

170. Another feature of the altered funding arrangements between 1990 and 1991 was that FGL effectively became the financier of the Finance Group and passed the cost of assuming this role, by charging interest on its loans, first to EFGA and later to EFGT which relayed the interest costs to EFGA. The Commissioner acknowledged that this arrangement "notionally balanced out" the additional cost to FGL of funding the Finance Group; cp,
Macquarie Finance Ltd v Commissioner of Taxation 2005 ATC 4829; (2005) 146 FCR 77 where it was held by French J, who was in the majority in the result, that interest payable by a subsidiary (MFL) to holders of notes stapled to preference shares in the parent company (MBL) was not deductible under s 8-1(1) because MBL had a capacity to redirect interest payments to MBL so that they would be received as dividends on the preference shares instead of interest on the notes. French J was persuaded to come to that conclusion because MFL's liability to pay interest on the notes was not tied to any income-producing purposes of its own but was incurred to procure a permanent capital increase for MBL's corporate group to satisfy capital adequacy requirements imposed by the Australian Prudential Regulation Authority.

171. In the present case, the Commissioner contended that, because there was no real prospect that EFGA or EFGT would ever pay interest on the loans, the arrangement just described involving the capitalisation and compounding of interest owed to FGL was "highly artificial" and a "device" to protect FGL's ability to pay dividends.

172. In a related way, the Commissioner contended that, to justify the claiming of deductions for interest on borrowings, each of FGL, EFGT, EFGA, Amayana, ELFIC and EFGS had to demonstrate a nexus between those borrowings and the derivation of assessable income. No such nexus could be demonstrated because the presumptive income was "illusory" in the sense that the parties knew that it would never be received by EFGA, EFGT, Amayana and FGL. As ELFIC and EFGS has no prospect of deriving income from the funds on which they were charged interest, the charges only served to create and, presumably, increase losses by those companies.

173. In support of his contentions in this context, the Commissioner pointed to differences of opinion within FGL about whether it should continue to charge interest on loans to subsidiaries. The decision to do so was said to reflect a concern to preserve the ability to pay dividends to FGL shareholders and retain the full advantage of the dividend rebate. Although he accepted that deductibility of interest expenses incurred by a taxpayer has to be assessed in the light of the circumstances obtaining in each tax year, the Commissioner contended that, in this case, there was no relevant change in any year from 1990 to 1998 because the endemic incapacity of the borrower companies prevailed and became worse throughout that time. That consideration reinforced the conclusion that EFGA had incurred its interest expenses to pursue advantages other than the production of income.

174.

ATC 10390

The Commissioner sought to distinguish the present case from
Federal Commissioner of Taxation v R & D Holdings Pty Ltd 2007 ATC 4731; (2007) 160 FCR 248. In that case, a corporate property developer had borrowed money to finance the construction of flats. The lender/mortgagee went into possession after the borrower defaulted and eventually sold the property after ten years. In the meantime, the mortgagee collected rent from the flats and paid the outgoings. Interest was capitalised from time to time with the result that, by the time of the sale, the borrower owed more than $100 million by way of capital and unpaid interest. The developer's claim of deductions for the interest was upheld at first instance and on appeal in this Court. The point of distinction between R & D Holdings on the present case, according to the Commissioner, is that, in that case, the arrangements between the taxpayer/developer and the mortgagee were at arm's length. The present case is more analogous to
Ure v Commissioner of Taxation 81 ATC 4100; (1981) 50 FLR 219 where the claim to deduct interest was apportioned having regard to its having been incurred for deductible and non-deductible purposes. In this case, the Commissioner contended, regard should be had to "what the expenditure was calculated to effect from a practical and business point of view"; see
Federal Commissioner of Taxation v Firth 2002 ATC 4346; (2002) 120 FCR 450. Here, the purpose of each expenditure on interest was to benefit FGL and the Foster's Group as a whole; see
Hooker Rex Pty Limited v Commissioner of Taxation 88 ATC 4392; (1988) 79 ALR 181.

The applicants' contentions on deductibility of interest claimed by ELFIC

175. It was submitted on behalf of ELFIC that it was entitled to deduction pursuant to s 51(1) of the 1936 Act for interest which it had incurred on the loans to it from EFGA. The basis of this submission was that the interest had been incurred in gaining or producing ELFIC's assessable income or had been necessarily incurred by ELFIC in carrying on a business of gaining or producing ELFIC's assessable income and was not a loss or outgoing of capital or of a capital nature.

Consideration of deductibility of interest claimed by ELFIC

176. In my view, the interest incurred by ELFIC on borrowings from EFGA was necessarily incurred in the carrying on by ELFIC of a business for the purpose of gaining or producing assessable income. It was not suggested on behalf of the Commissioner that those interest expenses were a sham. The fact that the interest expenses were significantly greater than the income derived by the taxpayer in each of the years in question does not entail that the expenses were not incurred in carrying on an income producing business. The disproportion is a reflection, rather, of the financial difficulties experienced by ELFIC's external customers in the late 1980's which resulted in diminished returns to ELFIC on the circulating capital deployed in its business. The business being conducted by ELFIC from 1990 onwards was the same business as had been carried on successfully since 1984. The fact that after 1990 ELFIC was in "wind down" mode did not alter the essential nature of that business. This is not a case like that identified in the passage from Fletchers's case quoted at [0] above where the disproportion between the expenditure on interest and the income derived is to be explained by reference to the independent pursuit of some objective other than the carrying on of ELFIC's core business. It does not follow that, because the core business was being wound down, the interest expenditure incurred in continuing the business was not wholly expended in carrying on the business. See, eg,
Commissioner of Taxation v Unilever Australia Securities Limited 95 ATC 4117; (1995) 56 FCR 152, where Beaumont J observed, at 165;

"Notwithstanding the respondent's decision not to undertake new financing activities, the 'defeasance' arrangements were part of the steps taken in connection with the respondent's business as a finance company. The fact that UAS was winding down its borrowing activities did not mean that the servicing of such borrowings as remained, including making arrangements for the payment to debenture holders, were not part

ATC 10391

of its ordinary business. It was not an 'unusual' transaction in the sense used by Mason J in International Nickel."

177. To similar effect, Hill J concluded, at 187;

"The present is not a case where UAS, in the relevant sense, put an end to its business by virtue of the defeasance transaction. Rather, although UAS had resolved not to expand its business but run it down, its business was still continuing. That business included the receipt of interest on funds lent out by it and the payment of interest on moneys borrowed by it. It continued at the least until the moneys borrowed had been repaid and indeed perhaps thereafter, or at least while moneys were owing to it, by Unilever related companies."

178. The distinction between expenditure incurred in carrying on a business, albeit one being wound down and that incurred after the business has been sold, or has otherwise ceased to be carried on, by the taxpayer was impliedly recognised by another Full Court of this Court in
Coal Developments (German Creek) Pty Ltd v Federal Commissioner of Taxation 2008 ATC 20-011; (2008) 166 FCR 140, at 152 [19], where the Court said:

"The fact that a former owner, after the sale of a business, retains liabilities in respect of some incidents of the business, such as a lease of real estate or machinery, does not require the conclusion that the former owner continues to carry on the same business after control of it has passed to the purchaser. The activities undertaken by CDGC in the present case, such as the assignment of mining leases and novation of rights under port user agreements and other contracts as well as the preparation of tax returns and the claiming of concessions for research and development, are more explicable, as a matter of fact, as having been engaged in as a consequence of the sale of the business rather than of its being 'wound down'."

Aspects of EFGA's activities relevant to its claim for a deduction in respect of interest

179. For the year ended 30 June 1998 EFGA claimed a deduction in respect of interest which it had incurred on funds borrowed from, or owed to, EFGT and Amayana. Part of the loans from EFGT had been used to repay loan funds previously advanced to EFGA by FGL and AML Finance. Those earlier loans and the later advances from Amayana had been used by EFGA to make loans at interest to the Finance Group subsidiaries. The interest charged to the subsidiaries had been returned as part of EFGA's assessable income.

180. The activities of EFGA were conducted with a view to making a profit by fixing interest rates charged to the borrowing entities by reference to the BBR plus a margin. The rates were competitive with those which the borrowing entities could have obtained on the open market from external lenders. EFGA also sought to maximise the return on the funds under its control by lending surplus moneys to third parties usually on the short-term money market. Each of the operating groups within EFGA was expected to, and usually did, make a profit after allocation to it of an appropriate part of EFGA's overhead expenses.

181. During the process of orderly realisation of the Finance Group assets, noted at [0] above, EFGA continued to lend at interest to other members of the Finance group including ELFIC and EFGS. From 1 September 1990 EFGA charged the borrowing entities interest at only the same rate at which EFGA was charged by internal lenders including FGL, EFGT and Amayana.

182. After the institution in 1991 of the security structure noted at [0] above, previously unsecured loans made to EFGA were repaid and replaced with secured interest-bearing loans channelled through EFGT. The flow of funds and accompanying securitisation and guarantees can be represented schematically as follows:

ATC 10392 

Flow of funds

183. EFGA made significant operating profits from 1984 to 1989 but thereafter recorded substantial operating losses between 1990 and 1998 except in 1995 when it recorded a relatively modest operating profit of $2,231,701. The operating losses were generally attributable to provisions raised to record diminution in the value of investments and loans, losses on the disposal of investments and, later, the writing off of bad debts. In every year from 1986 to 1998 except 1987, EFGA's reported income in the form of interest exceeded its expenses by way of interest on borrowed funds. That interest was included in EFGA's assessable income for each relevant year.

The applicants' contentions on deductibility of interest claimed by EFGA

184. It was submitted on behalf of EFGA that the interest charges which it had incurred on the advances to it by EFGT and Amayana were deductible under s 8-1 of the 1997 Act. The contention was essentially similar to that advanced on behalf of ELFIC which is outlined at [0] above.

Consideration of deductibility of interest claimed by EFGA

185. For essentially the reasons outlined in relation to the claim by ELFIC to deduct its interest expenses, I consider that the interest incurred by EFGA on its borrowings from EFGT was deductible under s 8-1 of the 1997 Act. The expenditure was calculated to effect from a practical and business point of view the continuing provision of funds at interest to the Finance Group subsidiaries to enable them to maintain their businesses as going concerns until they could be disposed of or closed down as part of the wind-up operation. That provision of funds was the central function which EFGA had assumed in the conduct of its business.

Aspects of Amayana's activities relevant to its claim for a deduction in respect of interest.

186. In the assessment issued to Amayana for the 1998 tax year, the Commissioner disallowed a deduction of $16,875,354 which had been claimed in respect of interest paid to FBGT on loans which had been on-lent at interest to EFGA. The interest on the loans to EFGA had been returned as part of Amayana's assessable income in the years in which it had

ATC 10393

accrued. In most years between 1991 and 1999 Amayana's costs of borrowing from FBGT matched its reported income in the form of interest from EFGA so that it recorded neither an operating profit nor an operating loss. During the same period, Amayana made payments of interest and repayments of principal to FBGT which totalled $124,338,706.

The applicants' contentions on the deductibility of interest claimed by Amayana

187. Amayana's submissions in support of the deductibility of the interest which it had incurred to FBGT were that an entitlement to a deduction for interest arose because Amayana had derived substantial income in the form of interest on the loans advanced by it to EFGA. The interest which Amayana had been required to pay was for the periodic use of funds which it had deployed as circulating capital in its business and was therefore on revenue account.

Commissioner's contention as to the deductibility of interest claimed by Amayana

188. The Commissioner relied in this context on the same general submissions as he had advanced in relation to all of the members of the Finance Group who had claimed to deduct interest on borrowed funds which had been on-lent to other members of the Group. He also contended, specifically in relation to Amayana, that part of EFGA's debt to Amayana had been forgiven as contemplated by s 245-15 of Schedule 2C of the 1936 Act.

Consideration of deductibility of interest claimed by Amayana

189. I consider that the reasons already outlined in respect of the claims for deductions in respect of interest by ELFIC and EFGA compel the same conclusion as to the claim for interest by Amayana. The funds which Amayana had borrowed had been used to derive assessable income in the form of interest from EFGA. The interest which Amayana had been required to pay represented the recurrent or periodic cost to it of securing those funds. I regard the activities of Amayana in the context of the Foster's Group as materially different from those of the group examined by Gyles J in Spassked (supra). There was, I consider, a frequent and often nice exercise of business judgment in conducting the affairs of Amayana and those of the related-party borrowers from it. Moreover, by contrast with Macquarie Finance (supra), Amayana's liability to pay interest to FGL was tied to Amayana's own income-producing purposes. I do not regard Amayana's prospect of receiving that income in the form of interest as "illusory" at the time when the interest was charged.

190. For the reasons explained at [202] below the debt due from EFGA was not forgiven as contemplated by s 245-35(12) of Schedule 2C of the 1936 Act. It follows that there was no impact by that provision on Amayana's ability to claim a deduction for interest on the funds which it had borrowed to lend to EFGA.

Aspects of the activities of EFGS relevant to its claim for a deduction of interest

191. EFGS was a subsidiary of ELFIC and initially obtained from that parent company the circulating capital used in its business. It began to borrow directly from EFGA after 1986 although it continued to borrow relatively small amounts from ELFIC. It was charged interest by EFGA on its borrowings from that company at EFGA's normal inter-company rate fixed by reference to the BBR plus a margin. From mid 1989, the Foster's Group began to realise certain EFGS assets as part of the process of realising assets of the Finance Group. EFGS continued to carry on business during the period to June 1998, including the management of its interest in the "Akron" joint venture into which assets of the Finance Group in the bloodstock industry had been transferred.

Applicants' contentions as to the deductibility of interest claimed by EFGS

192. It was contended on behalf of EFGS that the interest which it had incurred on the loans from EFGA was deductible pursuant to s 51(1) of the 1936 Act. The loans were properly recorded and were not suggested by the Commissioner to have been shams. The borrowed funds had been used by EFGS in the same business activities in which it had continuously been engaged since before 1987.

The Commissioner's contentions on the deductibility of interest claimed by EFGS

193. The Commissioner did not seek, in his submissions on the deductibility of interest, to distinguish between EFGS and other members

ATC 10394

of the Foster's Group which had incurred interest expenses on borrowed funds.

Consideration of the deductibility of interest claimed by EFGS

194. The reasons outlined above in relation to the claim made by ELFIC for a deduction in respect of interest apply with equal force to the corresponding claim by EFGS. The money borrowed from EFGA was used in the course of the business of EFGS which included the derivation of income and during the wind-up the realisation of loans to external customers and other interest-bearing assets. These considerations are reinforced by the accession of EFGS during the wind-up to the management of the Finance Group's interest in the "Akron" bloodstock joint venture.

Aspects of EFGT's activities relevant to its claim for a deduction in respect of interest

195. As noted at [0] above, EFGT claimed, in the tax year ended 30 June 1998, a deduction for interest which it had been required to pay to FGL under the Security Notes and Security Management Agreement. EFGT was part of the security structure that was set up between February and October 1991 as described at [0] above. Loan funds were channelled from FGL through EFGT to EFGA. As already indicated, the purpose of the new arrangement was to provide secured loans in place of previously unsecured loans so as to give FGL, as the ultimate lender, priority over the claims of unsecured creditors, particularly those which, at the time, were pursuing litigation against companies in the Finance Group. After its insertion into the structure, EFGT used the funds to make loans at interest to companies within the Foster's Group, particularly EFGA. EFGA in turn used the funds which it had borrowed from EFGT to repay loans to FGL and AML Finance. EFGT was required to pay interest to FGL at the 90 day BBR plus 1.5%. Interest continued to be charged in that way until the end of the 1998 financial year. As well, from 1992 to 1998 EFGT received money on deposit from other members of the Finance Group and was obliged to pay interest thereon to the depositors. Over the same period from 1992 to 1998 EFGT's business produced substantial assessable income, almost all of it by way of interest charged on loans which it made. It progressively made payments and repayments in respect of the debts which it owed to FGL.

Applicants' contentions on the deductibility of interest claimed by EFGT

196. The submissions advanced on behalf of EFGT in support of its claimed deduction for interest were essentially similar to the corresponding submissions on behalf of Amayana. It was submitted that EFGT was entitled to a deduction for interest which had incurred on loans from FGL under the security notes and the security management agreement. Counsel pointed to the fact already noted that EFGT had derived substantial income in the form of interest on the loans advanced by it to EFGA. The interest which EFGT had been required to pay was for the periodic use of the borrowed funds as part of its circulating capital and was therefore on revenue account; see
Australian National Hotels Ltd v Federal Commissioner of Taxation 88 ATC 4627; (1988) 19 FCR 234, at 240.

The Commissioner's contentions on the deductibility of interest claimed by EFGT

197. The Commissioner contended that the deduction for interest claimed by EFGT had properly been disallowed for essentially the same reasons as he had advanced in respect of the corresponding claim by ELFIC and EFGA.

Consideration of deductibility of interest claimed by EFGT

198. For the reasons already explained in respect of the claims by EFGA and Amayana to deduct interest, I have concluded that the similar claim by EFGT should have been allowed. The money which EFGT had borrowed from FGL was genuinely advanced to borrowers and deposit and interest was genuinely charged on it. Except for the interposition of the security structure, those transactions essentially continued the same income-producing activity which had been carried on since 1986. I do not regard the creation of the security structure or the purpose for which it occurred as having any relevant bearing on the entitlement of EFGT to claim a deduction for interest expenses actually incurred.

ATC 10395

Was the interest expenditure on capital account?

199. An alternative contention of the Commissioner proceeded from the premise that the essential character of the liability was to be determined by objectively identifying the nature of the advantage sought in incurring it. Although it was accepted that interest, as a periodically recurring liability securing the use of money during the term of the loan, is ordinarily a revenue item, the purpose of the interest payment may, in particular circumstances, be something other than raising or maintaining the borrowing. In those circumstances, the purpose of the borrowing might lead to its characterisation as being of a capital nature; see
Steele v Deputy Commissioner of Taxation 99 ATC 4242; (1999) 197 CLR 459, at 470. In the present case, the interest claimed to be deductible accrued after the Finance Group had ceased to be a going concern and after there was no longer any prospect of repaying the borrowed funds. The advantages gained were the protection of FGL's position as an unsecured creditor of the Finance Group, the preservation of the full rebate on dividends flowing to FGL and the "balancing out" of additional costs incurred by FGL in funding the Finance Group. The debt funding was directed to ensuring the survival of companies in the Finance Group and, so, to establishing and maintaining the capital structure of the Foster's Group as a whole. It was therefore on capital account.

200. As already indicated in relation to EFGS, I do not consider the fact that income-producing activities undertaken in the course of a business may have other purposes or effects militates against the entitlement of a taxpayer conducting those activities to deduct from the assessable income thereby produced an expense of a revenue nature incurred in deriving that income. Even if the corpus of the loan funds deployed by a lender is properly to be regarded as a capital asset in the hands of the lender, the interest paid to secure that capital sum or keep it in circulation is on revenue account. As Bowen CJ and Burchett J said, in
Australian National Hotels Ltd v Commissioner of Taxation 88 ATC 4627; (1988) 19 FCR 234, at 240;

"… If the capital is raised by loan, an investment of the borrowed moneys in a business will ordinarily remain an investment of capital, and the same consequences will follow. But there is a special feature of loan capital, which flows from the ephemeral nature of a loan. The cost of securing and retaining the use of the capital sum for the business, that is to say, the interest payable in respect of the loan, will be a revenue item. It creates no enduring advantage, but on the contrary is a periodic outgoing related to the continuance of the use by the business of the borrowed capital during the term of the loan."

Deductibility of losses transferred to Ashwick, Nexday and EFG investments

(i) Ashwick

201. A loss of $30,213 claimed to have been incurred by ELFIC in the 1997 income year was transferred to Ashwick all the shares in which were held by FGL either directly or through one or more interposed entities. If allowed, that claimed deduction would have reduced to nil Ashwick's taxable income for the 1997 year.

202. In the 1998 year of income FGL transferred to Ashwick a loss of $23,628 claimed to have been incurred by FGL in that year. That loss was part of a tax loss of $119,899,125 claimed to have been incurred in 1998 which was arrived at after deducting bad debts in respect of interest amounting to $408,058,393 which had been written off by FGL; see [0]-[0] above. If allowed, the claimed deduction of $23,628 would have reduced to nil Ashwick's taxable income for the 1998 tax year.

203. Later, in 2001, Ashwick claimed to deduct from its assessable income for that year a loss of $70 claimed to have been incurred by EFGA in 1998 which was transferred to Ashwick. That loss was part of a tax loss of $1,299,477,144 claimed to have been incurred by EFGA which included EFGA's claims for deductions for bad debts written-off by EFGA in respect of interest and principal owed to EFGA by ELFIC and EFGS; see [0], [0] and [0] above. The same loss also included the deductions claimed by EFGA for interest incurred on loans to EFGA from EFGT and Amayana; see [0] above.

204.

ATC 10396

That loss by EFGT was part of a tax loss of $525,437,631 which included EFGT's claim for a deduction for writing off as a bad debt the interest owed to EFGT by EFGA; see [0]-[0] above. It also included a claim for interest incurred on loans to EFGT from FBGT; see [0] above. The total claimed deductions of $145 if allowed, would have reduced to nil Ashwick's taxable income for the 1998 tax year.

205. Ashwick's claim for a deduction in the 1997 tax year has to be evaluated in the light of s 79E and s 80G of the 1936 Act. Section 79E, so far as is relevant, provided;

  • "(1A) This section does not apply to the 1997/98 year of income or a later year of income.
  • Note 1: To work out the amount of a tax loss for the 1997 98 year of income or a later year of income: see Division 36 of the Income Tax Assessment Act 1997.
  • Note 2: To find out how much of a loss incurred in a post 1989 year of income you can deduct for the 1997 98 year of income or a later year of income: see section 36 105 of the Income Tax (Transitional Provisions) Act 1997.
  • Note 3: For the rules about deducting tax losses from assessable foreign income for the 1997 98 year of income or a later year of income: see section 79DA.
  • (1) For the purposes of this section, a taxpayer incurs a loss in a post 1989 year of income equal to the amount (if any) by which the taxpayer's non loss deductions for the year of income exceed the sum of the taxpayer's assessable income and net exempt income for that year.
  • (2) In spite of subsection (1), if Subdivision B of Division 2A applies in relation to a taxpayer in relation to a post 1989 year of income, then, for the purposes of this section, the taxpayer incurs a loss in the year of income if, and only if, the taxpayer's current year loss amount for the year exceeds the taxpayer's net exempt income for the year, and the amount of the loss is equal to the excess.
  • (2A) In spite of subsection (1), if Schedule 2F applies in relation to a taxpayer for a post 1989 year of income, then, for the purposes of this section, the loss incurred by the taxpayer in the year of income is worked out under section 268 50 of that Schedule.
  • (3) Subject to this section, so much of a taxpayer's losses incurred in any of the post 1989 years of income before a particular year of income as has not been allowed as a deduction from the taxpayer's income of any of those years is allowable as a deduction in accordance with the following provisions:
    • (a) where the taxpayer has not derived exempt income in the particular year of income, the deduction is to be made from the taxpayer's assessable income of that year;
    • (b) where the taxpayer has derived exempt income in that year, the deduction is to be made successively from the taxpayer's net exempt income and from the taxpayer's assessable income of that year;
    • (c) where a deduction is allowable under this section in respect of 2 or more losses, the losses are to be taken into account in the order in which they were incurred.
  • (3A) If a loss referred to in subsection (3) is taken to be reduced under Subdivision 245 E of Schedule 2C in its application to the year of income or a previous year of income, any reference to that loss in this section is to be treated as a reference to that loss as so taken to be reduced.
  • (4) Where a taxpayer has incurred a loss in a post 1989 year of income for the purposes of this section and has also incurred a loss in that year for the purposes of section 79F, only the excess (if any) of the former loss over the latter loss is to be taken into account for the purposes of subsection (3).
  • (5) The losses referred to in subsection (3) are not allowable as a deduction from assessable foreign income of a taxpayer except to the extent provided in an election under subsection (6).
  • (6) A taxpayer who has derived assessable foreign income in a year of income may elect that the whole or a part of the losses referred to in subsection (3) be allowable as a deduction from the taxpayer's assessable foreign income of that year.

  • ATC 10397

    (7) An election under subsection (6) must be made on or before the date of lodgement of the return of income of the taxpayer for the year of income to which the election relates or within such further period as the Commissioner allows.
  • (8) In spite of any other provision of this section, if, before a year of income, a taxpayer:
    • (a) has become a bankrupt; or
    • (b) not having become a bankrupt, has been released from any debts by the operation of an Act relating to bankruptcy;
  • then no loss incurred by the taxpayer before the day on which the taxpayer became a bankrupt or was so released is an allowable deduction in respect of the year of income under subsection (3).
  • (8A) If:
    • (a) a taxpayer becomes a bankrupt, but the bankruptcy is later annulled; and
    • (b) disregarding the annulment, subsection (8) applies to the bankruptcy; and
    • (c) the annulment occurred under section 74 of the Bankruptcy Act 1966; and
    • (d) under the composition or scheme of arrangement concerned, the taxpayer has been, will be or may be, released from any debts, from which he or she would have been released if he or she had been instead discharged from the bankruptcy;
  • then, for the purposes of subsection (8), the annulment is disregarded.
  • (9) Where:
    • (a) in a year of income (in this section called the payment year), a taxpayer pays an amount in respect of a debt incurred by the taxpayer in a preceding year of income; and
    • (b) that preceding year of income (in this section called the loss year) is a year in which the taxpayer incurred a loss to which subsection (8) applies;
  • then, subject to subsection (10), the amount paid by the taxpayer is an allowable deduction for the payment year, but only to the extent (if any) that it does not exceed so much of the debt as the Commissioner is satisfied was taken into account in calculating the amount of the loss.
  • (10) The total deductions allowable to the taxpayer for the payment year under subsection (9) are not to exceed the amount of the loss reduced by the sum of:
    • (a) the deductions (if any) allowed under subsection (9) from the taxpayer's income of a year or years of income before the payment year in relation to the payment of other amounts in respect of debts incurred by the taxpayer in the loss year; and
    • (b) so much (if any) of the loss as has been allowed under subsection (3) as a deduction or deductions from the taxpayer's income (including the taxpayer's net exempt income) of a year or years of income before the payment year; and
    • (c) so much (if any) of the loss as, but for subsection (8), would have been allowed or allowable under subsection (3) as a deduction or deductions from the taxpayer's net exempt income of the payment year or of a year or years of income before the payment year.
  • (11) Subsections 80(5), (6) and (7) have the same effect in relation to deductions under subsection (3) of this section as they do in relation to deductions under subsection 80(2)."

206. The relevant parts of s 80G are subsections (6) and (6A) which were in these terms;

  • "(6) Subject to this section, where:
    • (a) a resident company other than a prescribed dual resident (in this section referred to as the loss company ) is deemed to have incurred a loss for the purposes of section 79E or 80 in the year of income that commenced on 1 July 1984 or in a subsequent year of income (in this section referred to as the loss year );

    • ATC 10398

      (b) a resident company other than a prescribed dual resident (in this section referred to as the income company ) has, or would but for the operation of this section have, a taxable income in the year of income that commenced on 1 July 1984 or in a subsequent year of income (in this section referred to as the income year );
    • (ba) the loss company is not a dual resident investment company in relation to the loss year nor in relation to the income year;
    • (c) the loss company and the income company agree that the right to an allowable deduction under subsection 79E(3), 79F(6), 80(2), 80AAA(7) or 80AA(4), as the case requires, in respect of so much of the whole or part of the loss as has not been allowed as a deduction should be transferred to the income company in the income year;
    • (d) in a case where the loss year is the same year of income as the income year:
      • (i) the loss company is a group company in relation to the income company in relation to the loss year; and
      • (ii) if the loss company had incurred the loss in the year of income immediately preceding the loss year and had derived sufficient assessable income (including film income) in the loss year, the loss or that part of the loss, as the case may be, would, but for this section, be allowable as a deduction from the assessable income of the loss company in the loss year (ignoring any exempt income derived by the loss company in the loss year or in that preceding year); and
    • (e) in a case where the income year is a year of income subsequent to the loss year:
      • (i) the loss company is a group company in relation to the income company in relation to the loss year and the income year and in relation to any year of income commencing after the end of the loss year and ending before the commencement of the income year; and
      • (ii) if the loss company had derived sufficient assessable income (including film income) in the income year, the loss or that part of the loss, as the case may be, would, but for this section, be allowable as a deduction from the assessable income of the loss company in the income year (ignoring any exempt income derived by the loss company in the income year);
    • the amount of the loss or of that part of the loss, as the case may be, shall, for the purposes of the application of the provisions of this Act other than this section in relation to the income company in relation to the income year, be deemed to be a loss incurred by the income company for the purposes of section 79E, 79F, 80, 80AAA or 80AA, as the case requires, in:
    • (f) a case to which paragraph (d) applies-the year of income immediately preceding the loss year; or
    • (g) a case to which paragraph (e) applies-the loss year.
  • (6A) An agreement under paragraph (6)(c) must be:
    • (a) in writing and signed by the public officer of each of the loss company and the income company; and
    • (b) made before the date of lodgement of the return of income of the income company for the income year or within such further time as the Commissioner allows.

The corresponding provisions of the 1997 Act applicable to the losses claimed in the 1998 and 2001 tax years are contained in Division 170 of the 1997 Act.

207. Counsel for Ashwick identified five requirements which have to be fulfilled for a transferred loss to be deductible under s 79E and s 80G of the 1936 Act. They were said to be:

208. Substantially the same five requirements were said to be imposed by Division 170 of the 1997 Act in respect of deductions claimed in the 1998 and 2001 years of income.

209. It was further submitted on behalf of Ashwick that each of the five requirements identified above had been satisfied in respect of the losses incurred by ELFIC, FGL, EFGA and EFGT and variously transferred to Ashwick in the 1997, 1998 and 2001 years of income.

210. According to Counsel for Ashwick, the Commissioner disputed the deductibility of the tax losses transferred to Ashwick only on the ground that the debts said to have given rise to the losses were affected by the Commercial Debt Forgiveness rules in Division 245 of Schedule 2C of the 1936 Act. It was accepted by Ashwick that the debts owed by EFGA to Amayana were "commercial debts" within the meaning of s 245-25 of Schedule C.

211. However, it was contended on behalf of Ashwick that forgiveness of a commercial debt as contemplated by Schedule C could only occur in one of three ways:

212. None of those modes of forgiveness, it was said, was applicable to the debts owed by EFGA to Amayana. They remained in existence as evidenced by a deed poll executed by Amayana on 31 July 1998 which recited:

"A Amayana ('the Creditor') is a creditor of EFG Australia Pty Ltd ('the Debtor') in respect of balances outstanding on advances and accruals of interest less repayments from time to time ('the Debt')."

213. Nothing was done by Amayana to release, waive or extinguish the debts owed to it by EFGA or from which an intention to do so could be inferred. The mere fact that the debts were written off did not signify that they had been released waived or otherwise forgiven. Moreover, it was said, the scheme of the 1997 Act contemplates that debts continue to exist after they have been written off. Attention was drawn in this context to s 20-20(3) which provides;

"Exclusion

  • (1) An amount is not an assessable recoupment to the extent that it is ordinary income, or it is statutory income because of a provision outside this Subdivision.

Insurance or indemnity

  • (2) An amount you have received as recoupment of a loss or outgoing is an assessable recoupment if:
    • (a) you received the amount by way of insurance or indemnity; and
    • (b) you can deduct an amount for the loss or outgoing for the current year, or you have deducted or can deduct an amount for it for an earlier income year, under any provision of this Act.

ATC 10400

Other recoupment
  • (3) An amount you have received as recoupment of a loss or outgoing (except by way of insurance or indemnity) is an assessable recoupment if:
    • (a) you can deduct an amount for the loss or outgoing for the current year; or
    • (b) you have deducted or can deduct an amount for the loss or outgoing for an earlier income year;
  • under a provision listed in section 20 30."

214. It was next submitted on behalf of Ashwick that the statute of limitations applicable to the debts due from EFGA to Amayana prescribes that time should commence to run from the date of the last payment or last acknowledgement. Regular acknowledgements had been made to Amayana on behalf of EFGA and part payments in reduction of the debt had been made throughout the currency of the loan including up to the end of the year ended 30 June 1999.

215. Finally it was said that there was no agreement or arrangement between Amayana and EFGA for the latter's obligation to pay the whole or part of the debts to cease at a particular future time. By way of proving this negative, reference was made to the resolution of Amayana's directors on 31 July 1998 to write-off as bad some of the debts owed by EFGA and to reduce to nil the rate of interest on the debts owing while reserving the right to increase the rate of interest in the future. Reliance for this purpose was also placed on Amayana's execution of the deed poll noted at [0] above.

Consideration of Ashwick's claimed deduction for a tax loss transferred from Amayana

216. I uphold the contention advanced by Counsel for Ashwick that the debts owed by EFGA to Amayana which were written off were not released, waived or otherwise extinguished as contemplated by s 245-35(12) of Schedule 2C of the 1936 Act. They were acknowledged in the accounts of EFGA in a manner held to be sufficient in
Stage Club Ltd v Millers Hotel Pty Ltd (1981) 150 CLR 535, at 566. Nor is there any discernible basis on which those debts could be said to be statute-barred or to have been the subject of an agreement whereby EFGA's obligation to pay them in whole or in part was to cease at a particular future time. It therefore follows that the debts, when written off, were available as a tax loss to Amayana which was transferable to Ashwick.

(ii) Nexday

217. In the 1999 year of income, Amayana incurred a loss under s 36-10 of the 1997 Act of $134,238,640. Included in the calculation of that loss was Amayana's claim to deduct as bad debts written-off the interest owed to Amayana by EFGA. In the 2000 year of income Nexday Pty Ltd ("Nexday"), a subsidiary, the shares in which were owned by FGL either directly or through one or more interposed entities, had taxable income of $139,290. Pursuant to a written loss transfer agreement executed before Nexday lodged its tax return for the 2000 year, Amayana transferred losses of $139,290 to Nexday. Amayana and Nexday were at all relevant times Australian resident companies.

Consideration of Nexday's claimed deduction for a tax loss transferred from Amayana

218. For essentially the same reasons advanced on behalf of Ashwick, it was contended that Nexday was entitled to a deduction under s 36-17 of the 1997 Act by operation of s 170-20 of that Act for the loss transferred to it by Amayana.

219. For the reasons explained at [0] above in respect of the tax loss claimed by Ashwick, the debts owed by EFGA to Amayana were available when written off to be transferred to Nexday.

(iii) EFG Investments

220. In the 1996 year of income, EFGS incurred a loss under s 79E of the 1936 Act of $7,560,282. Included in the calculation of that loss was a deduction for interest incurred on loans to EFGS from EFGA. In the 1996 year of income EFG Investments Pty Ltd ("EFG Investments"), a subsidiary the shares in which were wholly owned by FGL either directly or through one or more interposed entities, had taxable income of $1,391,715. Pursuant to a written loss transfer agreement executed before EFG Investments lodged its tax return for the 1996 tax year, EFGS transferred to EFG Investments losses of $739,340. EFGS and EFG Investments were at all relevant times Australian resident companies.

221.

ATC 10401

For essentially the same reasons advanced on behalf of Ashwick, it was contended that EFG Investments was entitled to a deduction under s 79E and s 80G of the 1936 Act for the loss transferred to it by EFGS.

Consideration of EFG Investment's claimed deduction for a tax loss transferred from EFGS

222. For the reasons advanced by Counsel for the applicants in respect of the deduction for the transferred tax loss claimed by Ashwick, I uphold the similar claim to a deduction made by EFG Investments. That claim was based on a loss constituted by a liability for interest and was apparently disputed by the Commissioner solely on the ground that the interest claimed was not allowable as a deduction to EFGS. As I have indicated at [0] above that the claim of EFGS to that deduction should be upheld, it follows that the transferred tax loss was deductible in the hands of EFG Investments.

Part IVA

223. As an alternative to his contention that the claimed deductions were not allowable under s 51(1) of the 1936 Act or s 8-1 or s 25-35 of the 1997 Act, the Commissioner contended that each of the applicants has obtained one or more "tax benefits" within the meaning of s 177C(1)(b) of the 1936 Act where "tax benefit" is defined, relevantly, as;

"… a deduction being allowable to the taxpayer in relation to a year of income where the whole or a part of that deduction would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer in relation to that year of income if the scheme had not been entered into or carried out …."

The existence of a "scheme"

224. The "scheme" identified by the Commissioner in invoking the application of Part IVA of the 1936 Act has been described as comprising "the steps taken by the Foster's Group to fund the Finance Group after November 1989 until 1998 by means of intra-group loans at interest." Those steps have been described inclusively, rather than exhaustively, at [183] of the Commissioner's Appeal Statement. In relation to EFGA, ELFIC and EFGS, the steps were identified as including EFGA's borrowing funds at interest from FGL, Amayana and EFGT, on-lending those funds at interest to ELFIC and EFGS, returning the interest so charged as assessable income and allocating repayments by ELFIC and EFGS to principal and not interest. Another step was identified as the writing-off in 1998 by EFGA as bad debts the moneys due from ELFIC and EFGS under the loans to those companies. A step said to have been taken by ELFIC and EFGS was the claiming by each of those companies as a deduction from its assessable income of the interest charged to it by EFGA. The participation of the Foster's Group as a whole in the scheme postulated by the Commissioner was said to involve the transfer of losses from EFGA, ELFIC and EFGS to Ashwick and EFG Investments. More specifically, FGL was said to have participated in the scheme by lending money at interest to EFGT for the making of loans to EFGA, returning the interest so charged as assessable income, allocating repayments by EFGT to principal, not interest, writing-off in 1998 as bad debts the amounts unpaid under the loans to EFGT and the transfer to other entities in the FGL of losses incurred by FGL. Similarly, EFGT's participation in the scheme was said to consist in its borrowing money at interest from FGL, making loans at interest to EFGA, returning the interest so charged as assessable income, claiming the interest charged by FGL as a deduction, allocating repayments by EFGA to principal, not interest, writing-off in 1998 as a bad debt the moneys due from EFGA under the loans to it and transferring EFGT's losses to other entities in the FGL, including Ashwick.

225. Amayana's participation in the scheme identified by the Commissioner was said to be its borrowing funds at interest from FBGTA, on-lending them at interest to EFGA, returning the interest so charged as assessable income, claiming a deduction for interest charged to it by FBGTA, allocating repayments by EFGA to principal, instead of interest, writing off as bad debts in 1999 the amounts unpaid by EFGA and transferring its (Amayana's) losses to other entities in the FGL including Nexday. Ashwick's, Nexday's and EFG Investments' participation in the scheme was said to be their claiming of deductions in relation to the losses respectively transferred to them.

226.

ATC 10402

The Commissioner acknowledged that the application of Part IVA "requires more than a possibility. It involves a prediction as to events which would have taken place if the relevant scheme had not been entered into or carried out and the prediction must be sufficiently reliable for it to be regarded as reasonable";
Peabody v Federal Commissioner of Taxation 94 ATC 4663; (1994) 181 CLR 359, at 385.

227. I am not persuaded that the steps taken between 1989 and 1998 to provide the members of the Finance Group with loan funds from internal, instead of external, sources amounted to a "scheme" within the meaning of s 177A(1) of the 1936 Act, which provides;

" 'scheme' means:

  • (a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and
  • (b) any scheme, plan, proposal, action, course of action or course of conduct."

228. I accept that a course of conduct may constitute a "scheme" even if it occurs as part of a larger series of transactions; see
Federal Commissioner of Taxation v Consolidated Press Holdings Ltd 2001 ATC 4343; (2001) 207 CLR 235, at 254 [52]. However, the internal provision of loan funds to ELFIC and EFGS from 1989 was not part of a coherent course of conduct but occurred as individual responses from time to time to external exigencies created by circumstances of the external financial climate. The fact that intra-group loans were made at interest does not signify the existence of a scheme. Intra-group loans had commenced before 1989. Moreover, the loans from external sources which they replaced had also been at interest and the charging of interest has been adequately explained by the need to preserve an index by which the performance or profitability of borrowers within the Finance Group could be measured.

Tax benefit

229. In case I am wrong in the conclusion just expressed, I proceed to consider whether a tax benefit was obtained by any of the applicants in connection with the scheme postulated by the Commissioner.

230. In the Commissioner's submission, if the scheme which he identified had not been entered into, interest would not have been charged to debtor companies within the Foster's Group after, at the latest, 1 July 1990. In that event, the debtor companies would not have been able to claim the interest as deductions and the creditor companies would not have been able to write off as bad debts moneys due to them as interest. In addition, EFGA derived a further tax benefit from the allocation of repayments made by it first to principal and secondly to interest, thereby increasing the component of the loan account balance attributable to interest.

231. The Commissioner further contended that, if FGL had not entered into the scheme, interest after 1990 would not have been charged within the Finance Group but the loans to those companies would have been treated as interest-free. Secondly, by allocating repayments on a first-in, first-out basis in accordance with the rule in Clayton's case, instead of applying them first to the liability for interest, FGL increased the amount of interest which was ultimately written off as bad debts in 1998. The resultant tax losses were transferred to the benefit of "income companies" in the Foster's Group.

232. A "tax benefit" is defined relevantly in s 177C(1) of the 1936 Act, in these terms:

  • "(1) Subject to this section, a reference in this Part to the obtaining by a taxpayer of a tax benefit in connection with a scheme shall be read as a reference to:
    • (a) an amount not being included in the assessable income of the taxpayer of a year of income where that amount would have been included, or might reasonably be expected to have been included, in the assessable income of the taxpayer of that year of income if the scheme had not been entered into or carried out; or
    • (b) a deduction being allowable to the taxpayer in relation to a year of income where the whole or a part of that deduction would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer in relation to that year of income if the scheme had not been entered into or carried out;"

      ATC 10403

233. Paragraph (d) of the same subsection provides further that for the purposes of Part IVA the amount of the tax benefit shall be taken to be -

"(d) in a case to which paragraph (b) applies-the amount of the whole of the deduction or of the part of the deduction, as the case may be, referred to in that paragraph;"

234. The tax benefits relied on by the Commissioner as flowing to various applicants were the deductions claimed for bad debts written-off, the deductions for interest expenses claimed to have been incurred and the deductions respectively claimed by Ashwick, Nexday and EFG Investments for transferred tax losses.

235. Making the prediction on the hypothesis enjoined by the High Court in
Federal Commissioner of Taxation v Peabody 94 ATC 4663; (1993) 181 CLR 359, I am not persuaded that, if the scheme postulated by the Commissioner had not been entered into, the deductions referred to in the last preceding paragraph would not have been allowable or might reasonably be expected not to have been allowable. I have already indicated, at [0] above, a basis on which interest could reasonably have been charged to borrowers in the Foster's Group even in the absence of the presumptive scheme. On that basis, the facility of lenders within the Group to write off as bad debts amounts of unpaid interest would still have existed and have provided the foundation for deductions being allowed to those lenders in the year or years in which the write-offs occurred.

236. There is also considerable force in the contention advanced on behalf of the applicants that, on the hypothesis required by s 177C(1) that the presumptive scheme had not been entered into, the interest income on which the deductibility of the bad debts written-off and the interest incurred on intra-group loans was predicated would not have been derived. On that hypothesis, the tax benefit imputed to the scheme propounded by the Commissioner would not have been achieved.

237. I also agree with the contention advanced on behalf of the applicants that the deductions claimed to have been available as a result of the transfers of tax losses to Ashwick, Nexday and EFG Investments, occurred as a result of the making of agreements expressly provided for by the Act. For the reasons already explained, I am satisfied that the presumptive scheme was not entered into for the purpose of enabling those agreements to be made. The agreements for the transfer of tax losses therefore fall within the exception created by s 177C(2)(b) of the 1936 Act which provides;

  • "(2) A reference in this Part to the obtaining by a taxpayer of a tax benefit in connection with a scheme shall be read as not including a reference to:
    • … … …
    • (b) a deduction being allowable to the taxpayer in relation to a year of income the whole or a part of which would not have been, or might reasonably be expected not to have been, allowable to the taxpayer in relation to that year of income if the scheme had not been entered into or carried out where:
      • (i) the allowance of the deduction to the taxpayer is attributable to the making of a declaration, agreement, election, selection or choice, the giving of a notice or the exercise of an option by any person, being a declaration, agreement, election, selection, choice, notice or option expressly provided for by this Act or the Income Tax Assessment Act 1997, except one under Subdivision 960 D of the Income Tax Assessment Act 1997; and
      • (ii) the scheme was not entered into or carried out by any person for the purpose of creating any circumstance or state of affairs the existence of which is necessary to enable the declaration, agreement, election, selection, choice, notice or option to be made, given or exercised, as the case may be;"

        ATC 10404

Purpose

238. In case I am wrong in concluding that the scheme alleged by the Commissioner was not entered into or carried out to obtain a "tax benefit" in the requisite sense, I turn now to consider the dominant purpose said to have actuated the entry into and carrying out of the alleged scheme.

239. The Commissioner, in the course of his submissions, examined each of the eight objective matters enumerated in s 177D(b) of the 1936 Act as requiring to be considered in order to identify the purpose of a scheme. Section 177D provides that Part IVA;

"… applies to any scheme that has been or is entered into after 27 May 1981, and to any scheme that has been or is carried out or commenced to be carried out after that date (other than a scheme that was entered into on or before that date), whether the scheme has been or is entered into or carried out in Australia or outside Australia or partly in Australia and partly outside Australia, where:

  • (a) a taxpayer (in this section referred to as the relevant taxpayer) has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme; and
  • (b) having regard to:
    • (i) the manner in which the scheme was entered into or carried out;
    • (ii) the form and substance of the scheme;
    • (iii) the time at which the scheme was entered into and the length of the period during which the scheme was carried out;
    • (iv) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme;
    • (v) any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme;
    • (vi) any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme;
    • (vii) any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out; and
    • (viii) the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (vi);
    • it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for the purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme or of enabling the relevant taxpayer and another taxpayer or other taxpayers each to obtain a tax benefit in connection with the scheme (whether or not that person who entered into or carried out the scheme or any part of the scheme is the relevant taxpayer or is the other taxpayer or one of the other taxpayers)."

240. It was accepted that the imputation to a taxpayer of a dominant purpose after consideration of the matters enumerated in s 177D(b) requires a comparison between the arrangement which effectuated the scheme and any alternative arrangement into which the taxpayer might have entered had the taxpayer not entered into the scheme arrangement. Thus, in
Federal Commissioner of Taxation v Hart 2004 ATC 4599; (2004) 217 CLR 216, Gummow and Hayne JJ observed, at 243-4 [66];

"In the present matters, the respondents would obtain a tax benefit if, in the terms of s 177C(1)(b), had the scheme not been entered into or carried out, the deductions 'might reasonably be expected not to have been allowable'. When that is read with s 177D(b) it becomes apparent that the inquiry directed by Pt IVA requires comparison between the scheme in question and an alternative postulate. To draw a conclusion about purpose from the eight matters identified in s 177D(b) will require consideration of what other possibilities existed. To say, as Hill J did, that 'the manner in which the scheme was formulated

ATC 10405

and thus entered into or carried out is certainly explicable only by the taxation consequences' assumes that there were other ways in which the borrowing of moneys for two purposes (one private and the other income producing) might have been effected. And it further assumes that those other ways of borrowing would have had less advantageous taxation consequences."

241. The Commissioner's submission then examined each of the eight matters enumerated in s 177D(b) with a view to identifying the light cast by it on the objective purpose of those responsible for entering into, and administering, the scheme.

(i) Manner in which the scheme was entered into or carried out - s 177D(b)(i)

242. Under this heading, the Commissioner instanced the refinancing of EFGA and, through it, the Finance Group, by loans made at interest and later, from 1992, by the making of loans from FGL at interest to EFGT which were then on-lent, also at interest, to EFGA which used the funds to repay the principal and interest on outstanding loans made to it by AML Finance and FGL. As well, EFGT, from the year ended 30 June 1992, made additional new loans at interest to EFGA using funds borrowed from FGL, also at interest. The actions of FGL in entering into that chain of transactions were said to be informed by FGL's knowledge that EFGA, ELFIC and EFGS lacked the ability to pay interest on their respective borrowings which, in turn, affected Amayana's ability to pay interest on its borrowings from FBGTA. Similarly, EFGA had no capacity to make regular and timely payments of interest on its borrowings from EFGT and Amayana.

243. The capitalisation and compounding from month to month of interest allowed it greatly to exceed the assets of the Finance Group, EFGT and Amayana. It was further said by the Commissioner that, as a result of EFGA having, in October 1991, given security over its assets to EFGT but having given no security to Amayana, Amayana's loan to EFGA became irrecoverable but was not written-off until July 1998. As well, the Commissioner claimed, the inclusion of EFGT and Amayana in the funding structure, "multiplied the bad debt deductions."

244. Members of the Finance Group, EFGT and Amayana were, in real terms, insolvent from November 1989 and were only enabled to continue to trade as a result of resolutions, letters of comfort and guarantees to external creditors given by FGL. The Commissioner also pointed to the change after 30 June 1994 in the allocation of repayments by internal creditors which were applied on a FIFO basis, first to repayment of older outstanding advances of capital.

245. Another feature of the treatment of debts internal to the Foster's Group to which the Commissioner pointed was the fact that companies within the Group which received transferred losses did not make subvention payments to the transferor companies. Such payments would have reduced the bad debts due from the loss companies and consequently have minimised the "losses" incurred by the creditor companies when they wrote-off as bad the debts owed by the debtor companies.

246. The matters identified by the Commissioner were said to go to the manner in which the scheme was entered into or carried out and to accentuate the predominance of a purpose of obtaining the tax benefits. The creditor companies did not gain the usual advantage of charging interest, namely a return on their loans. The economic advantage accrued solely in the form of tax benefits to the FGL as a whole.

247. I doubt whether any of the matters instanced by the Commissioner under this head goes to the "manner" in which the scheme to which he pointed was entered into or carried out. It has to be borne in mind that the question of dominant purpose will usually be determined at the time when the alleged scheme was entered into; see
Vincent v Commissioner of Taxation 2002 ATC 4742; (2002) 124 FCR 350, at 372. In the present case some of the matters relied on by the Commissioner such as the charging of interest to subsidiaries within the Finance Group predated the time ascribed by the Commissioner to entry into the scheme.

248. In any event, the features identified by the Commissioner as going to "manner" were explicable as actuated by a dominant purpose other than the obtaining of a tax benefit. The fact that intra-group loans to Finance Group

ATC 10406

subsidiaries were made at interest is at least as readily explicable by a concern to measure or monitor the performance of the borrowing companies. A similar observation can be made about the compounding or capitalising of the interest after timely payments had ceased to be made with any regularity. A corresponding explanation is available in respect of some loans based on the security structure which, as described at [0] above, had been erected in mid-1991 to provide a measure of protection for the Foster's Group assets from external creditors.

249. The delay in writing off bad debts owed by borrowers to lenders within the Foster's Group was, I consider, at least equally explicable by a belief held by the relevant finance officers before 1997 that the debts were not wholly irrecoverable. Support for that belief was available from the fact that repayments were made from time to time after 1992 by even the most heavily indebted subsidiaries as assets were realised.

250. I do not regard the allocation after 1994 of repayments by the borrowing subsidiaries on a "first in first out basis" as part of the manner of carrying out the alleged scheme which indicates the proscribed dominant purpose. Where separately identifiable debts or components of a debt were owed by a particular subsidiary, it was obviously necessary to make an election as to which debt or component was to be reduced or eliminated by a given part payment. The allocation of some of such part payments to reduction or elimination of the oldest advances of principal was logically justifiable otherwise than by reference to a tax benefit in the form of an ability at some time in the future to transfer within the Foster's Group tax losses which could not have been quantified at the time of each part payment. Similar considerations apply to the absence of subvention payments to the transferor loss companies which were parties to the tax loss agreements. The absence of such payments is explicable by the fact that the agreements were entirely "in house" so that any subvention would have had a purely neutral effect on the consolidated finances of the Foster's Group. The relatively small amounts of some of the tax losses involved also militates against the existence of a dominant purpose to obtain a tax benefit in the form of deductions for transferred losses claimable by the transferee companies.

(ii) The form and substance of the scheme - s 177D(b)(ii)

251. The Commissioner distinguished between the form of the scheme which contemplated the charging and payment of interest between companies in the Finance Group and the substance of the scheme which was that interest would never be paid, or paid in full but would be capitalised to increase the indebtedness of borrower companies which the creditor companies eventually wrote-off without suffering any economic loss. These differences between form and substance of the scheme were said to point to a purpose of avoiding tax.

252. I doubt whether there was a relevant difference between the form and substance of the scheme identified by the Commissioner. There is no suggestion that any of the intra-group loans or the accounting entries which evidenced the transactions were shams. It is true that in some significant instances interest on the loans was never paid in full but the substance as well as the form of the loan transactions did not contemplate a failure by some of the borrowers to pay interest in full.

(iii) Time of entry into alleged scheme and period during which it was carried out - s 177D(b)(iii)

253. The Commissioner pointed to the fact that, by 1990, it was apparent that ELFIC and EFGS could not repay principal and interest under existing loans which inability had a repercussive effect on EFGA as the internal treasury. Despite EFGA's making dramatically increasing provision between 1991 and 1997 for doubtful debts from intra-group borrowers, it did not write-off the debts as bad until June 1998, preferring, instead, to charge and capitalise interest on the outstanding loans.

254. The Commissioner also focused specifically on 19 June 1998 as the date on which EFGA, EFGT and FGL wrote off as bad debts the loan amounts respectively due to each of those companies. It was said that, by making the write-off take effect at 30 June 1998, "the creditor companies maximised the deductions that would be available, since interest continued to accrue up to 30 June 1998, even after the

ATC 10407

boards had resolved to write-off the loans." On the other hand, it was pointed out that Amayana's write-off in July 1998 had been "reasonably contemporaneous" with the actions of EFGA, EFGT and FGL but allowed Amayana to schedule the tax effect of the write-off for the year of income ended 30 June 1999.

255. In the light of the timing of the events outlined above and the period over which interest had been allowed to accrue, the Commissioner argued that it could readily be inferred that the scheme had been entered into primarily to obtain tax benefits.

256. Usually, in this context, the time of entry into a scheme is said to be significant because it coincides with, or is closely proximate to, the end of a tax year in which the presumptive tax benefit is sought to be obtained. In the present case, the scheme alleged by the Commissioner was said to have entered into after November 1989 so that 19 June 1998 cannot assume the significance which the Commissioner has attached to it. I can discern nothing in the events which occurred at about that time which tends to indicate that a purpose of the relevant actors was to obtain a tax benefit. Those events were a natural consequence, in the light of changed financial circumstances, of pre-existing arrangements between the members of the Foster's Group as a whole and of the arrangements to which particular members of the Finance Group were parties.

257. Similarly, the period over which the alleged scheme was carried out does not assist in imputing the requisite purpose to any relevant person. It is clear from the evidence that the period over which various arrangements were maintained between lenders and borrowers within the Foster's Group was dictated by the time needed to realise assets and make repayments of principal and interest. There is nothing to suggest that any presumptive tax benefit was predicated on an event occurring within, or after the lapse of, a particular period of time.

(iv) The result in relation to the operation of the Act that but for Part IVA would be achieved by the scheme - s 177D(b)(iv)

258. In this respect, the Commissioner pointed to the fact that the decision to fund the Finance Group by interest-bearing debt allowed deductions to be claimed in respect of interest by the lending companies and the writing-off as bad debts of unpaid interest. Had interest not been charged, and had repayments not been allocated on a first-in first-out basis, write-offs of $64,814,698 in the year ended 30 June 1998 would not have been available.

259. As indicated at [0] above, the result of the scheme in relation to the operation of the Act independently of Part IVA, was one for which the Act itself provided namely that interest returned as income could, if never received, be written off as a bad debt. I regard the application of this criterion as neutral on whether an intention to achieve a tax benefit can objectively be imputed to the relevant actors.

(v) Any change in the financial position of the relevant taxpayer that has resulted, or will result, or may reasonably be expected to result from the scheme - s 177D(b)(v)

260. The circumstances detailed under this head by the Commissioner essentially replicated aspects of the alleged scheme which have already been discussed. In particular, it was contended that, although the unpaid interest had been returned as income by creditor companies, the off-setting of those amounts by claims for deductions of interest on borrowed funds and the writing-off of bad debts "in effect resulted in a duplication of claims for tax deductions within the corporate group for the 1997-1998 period."

261. It was said that the failure to charge interest on intra-company loans meant that there was no net impact, apart from a beneficial tax impact, on the accounting positions of creditor companies within the Foster's Group. As well, the charging of interest on intra-group loans "washed out on consolidation" and was therefore of no concern to FGL. Correspondingly, the accrued interest expense had no effect on the ability of companies in the Foster's Group to discharge their obligations to external creditors or on the cash position of the Finance Group companies. The effect would have been the same had the scheme not been entered into.

262.

ATC 10408

The capitalisation and compounding of unpaid interest meant that it exceeded the interest on external borrowings to fund the Finance Group and "augmented the beneficial tax effects" of the tax deductibility of interest expenses and the dividend cash flow to FGL shareholders.

263. There were clearly changes in the respective financial positions of various members of the Foster's Group from time to time between 1989 and 2000. Many of those changes resulted from external forces which were regarded, for reasons unrelated to any tax benefit, as compelling internal adjustments of assets and liabilities and a re-arrangement of security over some assets. Some of those adjustments, although they involved a substitution of internal lenders for outside financiers, did not significantly change the financial position of the relevant borrower. Corresponding changes also resulted in some lending companies within the Foster's Group deriving assessable income in the form of interest on loans which had not been derived before the changes occurred. On balance, I do not regard these changes, or those more specifically indicated by the Commissioner, as strengthening or weakening the inference that the alleged scheme was entered into or carried out for the dominant purpose of obtaining a tax benefit.

(vi) Any change in the financial position of a person with a connection with the relevant taxpayer - s 177D(b)(vi)

264. It was said that entry into the scheme enabled the companies in the Foster's Group to claim deductions greatly exceeding "the real economic loss" suffered by the Group as a whole. That "real economic loss" was quantified by the Commissioner at $1,202,000,000 being the losses in the statutory accounts of the FGL for the 1990, 1991 and 1992 tax years less losses recovered between the years ended 30 June 1993 and 30 June 1996.

265. Attention was also drawn to the transfer of tax losses to profitable companies within the FGL reducing the amount of tax which those companies would otherwise have paid. Those tax losses could not have been generated without the financial support and comfort provided by FGL to enable insolvent borrowers within the Group to continue to incur losses. Consequences for companies other than the relevant taxpayers were reflected in tax savings generated by the scheme.

266. The changes identified by the Commissioner under this head were said to be consistent with the dominant purpose of obtaining the tax benefits flowing from the scheme.

267. Because of the elaborate inter-connected group structure of FGL and its subsidiaries action taken in response to changed financial circumstances in respect of one member of the Group necessarily had repercussion for one or more other members of the Group. However, I do not regard any changes in the financial position of one or more Foster's Group companies which were connected in that way to a particular taxpayer member of the Group as having any purposive significance of the kind to which s 177D(b)(vi) points. In my view, all of the changes which can be characterised as relevant to this criterion have been evaluated in the application of the criteria erected by sub-paragraphs (i), (iii) and (v) of s 177D(b).

(vii) Any other consequences for the relevant taxpayer or for any person referred to in (vi) of the scheme being entered into or carried out - s 177D(b)(viii)

268. The Commissioner accepted that there were no other consequences for the applicants or for any person referred to in (vi).

(viii) Nature of any connection between the relevant taxpayer and any person referred to in (vi) - s 177D(b)(viii)

269. The Commissioner reiterated that the companies referred to under (vi) had all been wholly-owned subsidiaries of FGL and subject to its direction in the implementation of intra-group funding arrangements. Under that direction, the lending companies had continued to make advances to the borrowers at interest in circumstances in which no independent lender would have done so.

270. The inter-connection between companies in the Foster's Group and the fact that they were subject to the overall direction of FGL has already been noted and evaluated in the application of other criteria postulated in s 177D(b). The making of loans and the giving of

ATC 10409

guarantees and letters of comfort to borrowers within the group which would have been hopelessly insolvent if considered as independent entities, is readily explicable by the need to preserve the financial viability of the Foster's Group as a whole. In my view, those features of the nature of the connection does not support any inference that the dominant purpose of those who administered the connected activities of the Foster's Group was to obtain a tax benefit.

Conclusion as to Part IVA

271. For the reasons which I have endeavoured to explain, I have concluded that Part IVA of the 1936 Act is not available to support the disallowance of the deductions which earlier in these reasons I have held to be otherwise available to one or other of the applicants. In summary, I have reached that conclusion because, on balance, I have not been persuaded that the steps described by the Commissioner as having been taken by the Foster's Group between 1989 and 1998 constituted a "scheme" within the meaning of Part IVA.

272. In the second place, that "tax benefits" in the requisite sense would have been derived had the presumptive "scheme" not been disallowed under Part IVA. Thirdly, if contrary to my view there were such tax benefits, I have found that the presumptive scheme was not entered into for the dominant purpose, objectively ascertained, of obtaining those benefits.

General conclusion

273. In the light of the conclusions which I have reached on each of the four main issues identified at [0] above, it si appropriate to indicate in a summary way the disposition of each of the proceedings before the Court which I consider those conclusions require.

(i) Proceeding numbered VID 861 of 2006; Ashwick (Qld) No 127 Pty Ltd

274. This proceeding is an appeal against a deemed disallowance of an objection to a decision by the Commissioner not to allow a deduction in respect of the same transferred tax losses of $70 and $75 which are the subject of proceedings numbered VID 125 of 2007. The earlier proceedings has thus been overtaken and it is unnecessary to make any substantive order in it. These proceedings numbered VID 861 of 2006 will accordingly be dismissed with no order as to costs.

(ii) Proceedings numbered VID 123 of 2007, VID 124 of 2007 and VID 125 of 2007; Ashwick (Qld) No 127 Pty Ltd

275. These proceedings respectively concerned the disallowance of a transferred tax loss for each of the 1997, 1998 and 2001 tax years. In light of the conclusion indicated at [0] of these reasons there should be an order in each proceeding that the appeal against the objection decision be allowed, the assessment of 18 December 2006 be set aside and the assessment be remitted to the Commissioner for reassessment in accordance with the reasons of the Court published this day. The Commissioner must pay Ashwick's costs of each proceeding.

(iii) Proceeding numbered VID 126 of 2007; Nexday Pty Ltd

276. This proceeding was confined to the disallowance of a claimed tax loss which had been transferred from Amayana to Nexday. Apart from his invocation of Part IVA, the Commissioner relied on a contention that because of deductions claimed by Amayana and properly disallowed there was no transferable tax loss. As indicated at [0]-[0] of these reasons the Commissioner's contention has not been upheld. Accordingly, there should be an order in this proceeding that the appeal against the objection decision be allowed, the assessment of 18 December 2006 be set aside and the assessment be remitted to the Commissioner for reassessment in accordance with the reasons of the Court published this day. The Commissioner must pay Nexday's costs of the proceeding.

(iv) Proceeding numbered VID 127 of 2007; EFG Investments Pty Ltd

277. Apart from his invocation of Part IVA, the Commissioner's disallowance of the deduction claimed by EFG Investments was based solely on the contention that the interest component of the tax loss transferred to EFG Investments by EFGS was not allowable as a deduction to EFGS. As indicated at [0] of these reasons, for the reasons explained at [0] above, the claim by EFGS to deduct interest has been upheld. There should therefore be an order in

ATC 10410

this proceeding that the appeal against the objection decision be allowed, the assessment of 18 December 2006 be set aside and the assessment be remitted to the Commissioner for reassessment in accordance with the reasons of the Court published this day. The Commissioner must pay EFG Investments' costs of the proceeding.

(v) Proceeding numbered VID 128 of 2007, Amayana Pty Ltd

278. This proceeding involves a claim by Amayana for a deduction in the 1998 tax year in respect of interest on loans from FBGT. For the reasons indicated at [0]-[0] above the claim for that deduction should have been allowed. There should therefore an order in this proceeding that the objection appeal be allowed, the assessment of 18 December 2006 be set aside and the assessment be remitted to the Commissioner for reassessment in accordance with these reasons. The Commissioner must pay Amayana's costs of the proceedings.

(vi) Proceeding numbered VID 129 of 2007; Foster's Group Ltd

279. The claim in this proceeding was confined to one for the deductibility of bad debts written off. As explained at [0]-[0] above that claim has succeeded but only in respect of the interest component of the relevant bad debt. There will therefore be an order in this proceeding that the objection appeal be allowed, the assessment of 18 December 2006 be set aside and the assessment be remitted to the Commissioner for reassessment in accordance with these reasons. The Commissioner must pay FGL's costs of the proceedings.

(vii) Proceedings numbered VID 130 of 2007, VID 133 of 2007 and VID 134 of 2007; Elfic Pty Ltd

280. Each of these proceedings concerned a claim by ELFIC to deduct an expense in the form of interest on intra-group borrowings for each of the 1996, 1996 and 1997 tax years. As explained at [0]-[0] above, ELFIC's claim has been upheld for each of the relevant years. There must therefore be an order in each proceeding that the objection appeal be allowed, the assessment of 18 December 2006 be set aside and the assessment be remitted to the Commissioner for reassessment in accordance with these reasons. The Commissioner must pay ELFIC's costs of each proceeding.

(viii) Proceeding numbered VID 131 of 2007; EFG Treasury Pty Ltd

281. These proceedings arose from the disallowance of an objection to an assessment which disallowed EFT's claim for a deduction in respect of interest and for a debt owed by EFGA to EFT which was written off as bad. For the reasons indicated at [0] above, the claim for interest should have been allowed. In addition, as explained at [0]-[0] of these reasons EFGT's claim for the bad debt deduction has also succeeded. There should, accordingly, be an order in this proceeding that the objection appeal be allowed, the assessment of 18 December 2006 be set aside and the assessment be remitted to the Commissioner for reassessment in accordance with these reasons. The Commissioner must pay EFGT's costs of the proceeding.

(vix) Proceeding numbered VID 132 of 2007; EFG Australia Pty Ltd

282. This proceeding concerned both a claim for a deduction in respect of bad debts written off in the year ended 30 June 1998 and a claim in the same year for interest owing to other entities in the Foster's Group. The bad debts deduction has bee upheld in respect of both principal and interest as explained at [0]-[0] above. EFGA's claim for a deduction in respect of the liability for interest has also succeeded as indicated at [0] above. There should therefore be an order in this proceeding that the objection appeal be allowed, the assessment of 18 December 2006 be set aside and the assessment be remitted to the Commissioner for reassessment in accordance with these reasons. The Commissioner must pay EFGA's costs of the proceeding.

(x) Proceeding numbered VID 135 of 2007; EFG Securities Pty Ltd

283. This proceeding concerns a claim for a deduction in the 1997 tax year for interest payable by EFGS to EFGA. As appears from [0] of these reasons the deduction claimed by EFGS should have been allowed. There should therefore be an order in this proceeding that the objection appeal be allowed, the assessment of

ATC 10411

18 December 2006 be set aside and the assessment be remitted to the Commissioner for reassessment in accordance with these reasons. The Commissioner must pay EFG Securities' costs of the proceeding.

 

Disclaimer and notice of copyright applicable to materials provided by CCH Australia Limited

CCH Australia Limited ("CCH") believes that all information which it has provided in this site is accurate and reliable, but gives no warranty of accuracy or reliability of such information to the reader or any third party. The information provided by CCH is not legal or professional advice. To the extent permitted by law, no responsibility for damages or loss arising in any way out of or in connection with or incidental to any errors or omissions in any information provided is accepted by CCH or by persons involved in the preparation and provision of the information, whether arising from negligence or otherwise, from the use of or results obtained from information supplied by CCH.

The information provided by CCH includes history notes and other value-added features which are subject to CCH copyright. No CCH material may be copied, reproduced, republished, uploaded, posted, transmitted, or distributed in any way, except that you may download one copy for your personal use only, provided you keep intact all copyright and other proprietary notices. In particular, the reproduction of any part of the information for sale or incorporation in any product intended for sale is prohibited without CCH's prior consent.