IEL FINANCE LTD & ORS v FC of T

Members:
Emmett J

Tribunal:
Federal Court, Sydney

MEDIA NEUTRAL CITATION: [2010] FCA 898

Decision date: 20 August 2010

EMMETT J

Introduction

1. These four proceedings were heard together. The principal question in each proceeding is whether interest expenses incurred by Spassked Pty Limited ( Spassked ) to IEL Finance Limited ( IEF ) were allowable deductions of Spassked under s 51(1) of the Income Tax Assessment Act 1936 (Cth) ( the Assessment Act ). Spassked incurred the interest expenses in question in the years of income ended 30 June 1991 ( the 1991 Year ), 30 June 1993 ( the 1993 Year ) and 30 June 1994 ( the 1994 Year ).

2. As a result of the interest expenses, Spassked incurred losses in each of the 1991, 1993 and 1994 Years. In the 1991 Year, Spassked transferred to Queensland Trading and Holding Company Limited ( QTH ), under s 80G of the Assessment Act, losses incurred by Spassked in the 1991 Year. In the 1993 Year and in the year ended 30 June 1996 ( the 1996 Year ), Spassked transferred to IEF, under s 80G, losses incurred in the 1993 Year and the 1994 Year. QTH and IEF claimed the amounts of the losses transferred as allowable deductions.

3. The respondent, the Commissioner of Taxation ( the Commissioner ), disallowed Spassked's claims for deductions in respect of the interest expenses incurred in the 1991 Year, the 1993 Year and the 1994 Year. As a consequence, the Commissioner also disallowed the claims by QTH and IEF to be entitled to deduct the losses transferred by Spassked. In addition, the Commissioner determined, under s 177F(1) of the Assessment Act, that the deductions should not, in any event, be allowable because a tax benefit had been obtained in connection with a scheme to which Part IVA of the Assessment Act applied.

4. The Commissioner issued assessments to each of Spassked, IEF and QTH (together the Taxpayers ) in respect of the relevant years. Taxation objections were lodged by the Taxpayers under s 14ZU of the Taxation Administration Act 1953 (Cth) ( the Administration Act ) and the Commissioner made objection decisions disallowing the objections. The Taxpayers then appealed to the Court, under s 14ZZ of the Administration Act, from the relevant objection decisions.

5. There are four appeals before the Court ( the Current Proceedings ). Proceeding NSD 94 of 2005 relates to an assessment issued to Spassked in respect of the 1994 Year. Proceeding NSD 539 of 2004 relates to an assessment issued to IEF for the 1993 Year and Proceeding NSD 543 of 2004 relates to an assessment issued to IEF for the 1996 Year. Proceeding NSD 540 of 2004 relates to an assessment issued to QTH for the 1991 Year.

6. The Commissioner sought the summary dismissal of all four appeals on the basis that the Taxpayers were estopped from asserting that the interest expenses incurred by Spassked in the 1991 Year, the 1993 Year and the 1994 Year were allowable deductions. The Commissioner claimed that the estoppel arose from an unsuccessful appeal by Spassked from an objection decision made by the Commissioner in relation to an objection by Spassked in respect of an assessment issued by the Commissioner in respect of the year ended 30 June 1992 ( the 1992 Year ). That appeal by Spassked was dismissed on 14 February 2003 (see
Spassked Pty Ltd v Commissioner of Taxation (No 5) [2003] FCA 84) ( the Earlier Proceeding ), and an appeal from that decision to the Full Court ( the First Full Court ) was also dismissed (see
Spassked Pty Ltd and Others v Commissioner of Taxation [2003] FCAFC 282).

7. A judge of the Court accepted the Commissioner's contention that Spassked was estopped from asserting that the interest expenses incurred in the 1991 Year, the 1993 Year and the 1994 Year were allowable deductions and ordered summary dismissal of each of the Current Proceedings. However, an appeal to the Full Court from those orders was successful (see
Spassked Pty Ltd and Others v Federal Commissioner of Taxation (No 2) [2007] FCAFC 205) ( the Second Full Court ). Nevertheless, the Commissioner contends that he is entitled to rely on the determination in the Earlier Proceeding as an answer to the Taxpayers' claims in the Current Proceedings.

8. Much of the factual background relevant to the Current Proceedings was examined in detail in the Earlier Proceeding. Further, significant parts of the evidence in the Earlier Proceeding are also evidence in the Current Proceedings. However, the Taxpayers invite the Court to consider the evidence in a light different from the light that they endeavoured to throw on that evidence in the Earlier Proceeding.

9. Before dealing with the issues, it is desirable to say something about the relevant statutory provisions and the legal principles relevant to the interpretation of those provisions. I shall also say something about the Taxpayers and the relevant factual background. Each of the Taxpayers is a subsidiary of Industrial Equity Limited ( IEL ). The relevant background includes the takeover of IEL by Dextran Pty Limited ( Dextran ). Dextran is jointly owned by companies in the Adsteam Group, which I shall describe below.

The law

10. There are several discrete provisions relevant to the appeals. I shall deal with them separately.

Allowable deductions: Section 51(1)

11. The pivotal provision for present purposes is s 51(1) of the Assessment Act. Section 51(1) relevantly provides that all losses and outgoings, to the extent to which they are incurred in gaining or producing assessable income , or are necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income , are allowable deductions. The jurisprudence surrounding s 51(1) is extensive. While there is little dispute between the parties as to the general principles, there is considerable scope for dispute concerning the application of the general principles to particular circumstances.

12. Expenditure will be an allowable deduction only if it is incidental and relevant to the gaining or producing of assessable income. The expenditure must be incurred in the course of gaining or producing assessable income. It is both sufficient and necessary that the occasion of the expenditure should be found in whatever produces assessable income or, if none is produced, what would be expected to produce assessable income (see
Ronpibon Tin No Liability v Commissioner of Taxation (1949) 78 CLR 47 at 56-7).

13. The first limb of s 51(1) is directed to expenditure incurred in the actual course of producing assessable income. It is concerned primarily with expenditure voluntarily incurred for the sake of producing income. However, its scope is not confined to cases where the income is derived from carrying on a business. The second limb is more concerned with cases where, in the carrying on of a business, some abnormal event or situation leads to an expenditure that it is not desired to make, but is made for the purposes of the business generally and is reasonably regarded as unavoidable. The references to assessable income in s 51(1) are references to assessable income generally of a taxpayer and not to the assessable income of a particular accounting period (see
Federal Commissioner of Taxation v Total Holdings (Australia) Pty Ltd (1979) 43 FLR 217 at 221-2). The reference in s 51(1) to assessable income is not to be understood as being confined to assessable income actually derived in the particular tax year. Rather, it is to be construed as an abstract phrase that refers not only to assessable income derived in that or in some other tax year but also to assessable income that the relevant outgoing would be expected to produce (see
Steele v Deputy Commissioner of Taxation (1999) 197 CLR 459 at 467).

14. In determining the deductibility under s 51(1) of interest expenses, it is not necessarily sufficient to rely on the test of the purpose of the borrowing or the test of the application of the funds. Thus, a taxpayer who borrowed funds for an income producing purpose would not be entitled to continue to receive a deduction after the income producing activity ceased. Similarly, if funds are borrowed to purchase an asset that is not to be used for an income producing activity, but the asset is later used for the purpose of an income producing activity, the interest expense would thereafter be deductible. The question that arises under s 51(1) is whether the interest outgoing was incurred in the course of the income producing activity or, in the case of the second limb, whether the interest outgoing was incurred in the course of a business activity that is directed towards the gaining or producing of assessable income (see
Kidston Goldmines Ltd v Commissioner of Taxation (1991) 30 FCR 77 at 85) ( Kidston Gold Mines Case ).

15. The question of whether an outgoing is, for the purpose of s 51(1), wholly or partly incurred in gaining or producing assessable income is a question of characterisation. The relationship between the outgoing and the assessable income must be such as to impart to the outgoing the character of an outgoing of the relevant kind. An outgoing will not properly be characterised as having been incurred in gaining or producing assessable income unless it is incidental and relevant to that end. However, to say that it is both sufficient and necessary that the occasion of the loss or outgoing be found in what is productive of the assessable income or, if none be produced, would be expected to produce assessable income, is not to exclude the motive of the taxpayer in making the outgoing as a possibly relevant factor in characterisation for the purposes of the first limb of s 51(1). Where an outgoing has been voluntarily incurred, the end that the taxpayer subjectively had in view in incurring it may, depending upon the circumstances of the particular case, constitute an element, and possibly the decisive element, in characterisation of either the whole or part of the outgoing. There must be a genuine, and not colourable, relationship between the whole of the expenditure and the production of the relevant income. It is not for the Court, or the Commissioner, to say how much a taxpayer ought to spend in obtaining his income. The function of the Court and the Commissioner is to determine only how much the taxpayer has spent. However, the position may be different where no relevant assessable income can be identified or where relevant assessable income is less that the amount of the outgoing (see
Fletcher v Commissioner of Taxation (1991) 173 CLR 1 at 17-18).

16. Section 51(1) is necessarily expressed in language of generality. It provides for the deduction of the larger variety of losses or outgoings than might be described compendiously as normal working outgoings or normal business expenses. There must be a perceived connection between the loss or outgoing, on the one hand, and the assessable income or business, on the other. Alternatively, the expenditure must be incidental and relevant to the operations or activities regularly carried on by the taxpayer for the production of income. It is necessary to identify the essential character of the expenditure in order to determine whether a particular loss or outgoing is in fact incurred in gaining or producing the assessable income or in carrying on a business, which more directly contributes to the gaining or production of the assessable income. The use of the words "to the extent to which" in s 51(1) indicates that losses and outgoings may be apportioned in an appropriate case. If the loss or outgoing has some connection with the assessable income or the business, but, in addition, has some connection that is not a connection contemplated by the section, it will be necessary to apportion the loss or outgoing at that point (see
Commissioner of Taxation v Firth (2002) 120 FCR 450 at 452-3).

17. In many, if not most, cases, the objective relationship between an expenditure and that which is productive of income will provide a sufficient answer to the enquiry called for by s 51(1). In many cases, questions as to a taxpayer's motives, beyond what may be the outcomes sought, may introduce an unnecessary evidentiary complication into the relevant enquiry. Motive may be relevant in the context of a voluntary expenditure. In such circumstances, explanation may be seen as necessary. In most cases, the reason for the expenditure will be apparent and it will not be necessary to enquiry further. The question of whether the expenditure has been incurred in gaining or producing income will look to the scope of the operations or activities and their relevance to expenditure, rather than to a taxpayer's reason for the expenditure (see
Commissioner of Taxation v Day (2008) 236 CLR 163 at 183-4).

Dividend rebates: Section 46

18. In order to explain the circumstances of Spassked's claim to be entitled to a deduction in respect of its interest expenses, it is necessary to say something about dividend rebates under s 46 of the Assessment Act. Under s 46(2)(b), a shareholder, being a company that is a resident, was entitled to a rebate in its assessment in respect of income of the year of income of the amount obtained by applying the average rate of tax payable by the shareholder in relation to the year of income, to the part of any dividends that is included in its taxable income. Section 46(7) provided that, for the purposes of s 46(2), the part of any dividends that is included in the taxable income of a shareholder of a year of income is so much of the taxable income as equals the amount, if any, of the dividends included in the assessable income of the shareholder of the year of income. However, if the taxable income is equal to, or less than, the amount of the dividends included in the assessable income of the shareholder of the year of income, the whole of the taxable income is included in the taxable income of the shareholder of the year of income.

19. The effect of those provisions is that a dividend was included in the assessable income of the shareholder receiving the dividend, which then became entitled to a rebate of the tax payable on the dividend. However, before the tax payable on the dividend was calculated, there was required to be deducted from the amount of the dividend, any amounts directly incurred in earning that dividend. If the shareholder deriving the dividend had incurred interest that was an allowable deduction, because the amount borrowed had been used to acquire the shares on which the dividends were paid, the interest had to be deducted from the dividend before the rebate was calculated. Where the interest incurred was equal to, or exceeded, the dividend, the result was that there was no taxable income upon which tax could be calculated and no tax payable on the dividend that could be rebated. The amount of the rebate allowable was to be no greater than the tax payable on the dividend. The consequence was that the inter-company dividend rebate was lost to the shareholder (the First Full Court [11]).

Dividend imputation

20. Dividend imputation was introduced in Australia, in respect of years after 30 June 1987, in order to alleviate what was seen to be the double tax payable as a result of the classic system of taxation of companies and their shareholders. In the classic system, the company pays tax on its taxable income and shareholders pay, additionally, tax on dividends they receive. Full dividend imputation would have the consequence that the shareholder, being a resident individual receiving a dividend out of profits already subjected to tax in the hands of the company, would effectively receive a credit of the tax payable by the company and thus suffer no additional income tax on the dividend. However, that consequent follows only if the rates of tax payable by companies and shareholders are aligned. That alignment does not exist in Australia and, accordingly, the system adopted provides only partial and not full imputation (the First Full Court at [12]).

21. A dividend may be wholly or partially franked or unfranked, depending upon whether it was paid wholly or only partially out of profits that had borne tax in the hands of the company. If the dividend was paid wholly out of profits that had borne tax in the hands of the company, the shareholder received a credit for the tax paid by the company. The dividend is referred to as a franked dividend . The value of the credit, referred to as a franking credit , was added to the cash dividend. That is to say, there was a grossing up of the dividend and the amount of the franking credit. The resulting figure was included in the taxable income of the shareholder. The shareholder then received a credit for the tax paid by the company. Clearly enough, a shareholder who was an individual would generally prefer to receive a franked dividend. Where the shareholder is a company, the benefit of the franked dividend, and thus the franking credit, could be passed up through a hierarchy of companies through to the parent company and thence directly or indirectly through to an individual shareholder (see the First Full Court at [13]).

Transfer of tax losses: Section 80G

22. In order to explain the position of QTH and IEF in relation to their respective proceedings, it is also necessary to say something about the provisions of the Assessment Act dealing with the availability of losses in previous years as an allowable deduction and the provisions for the transfer of losses from one company within a wholly owned group to another company within the group. Under s 79E(1) of the Assessment Act, a taxpayer incurs a loss in a year of income equal to the amount, if any, by which that taxpayer's non-loss deductions for the year of income exceed the sum of that taxpayer's assessable income for that year. Under s 79E(3), so much of a taxpayer's losses incurred in any of the years of income before a particular year of income as has not been allowed as a deduction from that taxpayer's income of any of those years is allowable as a deduction.

23. Section 80G deals with the transfer of loss within a company group. Under s 80G(1), a company is to be taken to be a group company, in relation to another company in relation to a year of income, if one of the companies was a subsidiary of the other company or each of the companies was a subsidiary of the same company during the whole of the year of income. Section 80G(6) relevantly provides that where:

the amount of the loss is, for the purposes of the application of the provisions of the Assessment Act in relation to the Income Company in relation to the Income Year, deemed to be a loss incurred by the Income Company for the purposes of s 79E.

24. Section 80G(6) was in a different form as applicable to the 1993 Year and subsequent years. Rather than a requirement that the Loss Company and the Income Company give notice to the Commissioner, the requirement was that the Loss Company and the Income Company agree that the right to an allowable deduction under s 79E(3) should be transferred to the Income Company in the Income Year. However, in the Current Proceedings, nothing turns on that difference. In each case, the relevant requirement was satisfied.

Dividend traps

25. The effect of the provisions of s 79E and 80G, in conjunction with s 51(1), is that a company that had borrowed money at interest to acquire shares would ordinarily obtain a deduction for the interest that it incurred in the year of income. If the company had, in the year of income, derived income against which the interest deduction could be offset, the company would have incurred a loss in the year of income. That loss could be transferred to a group company, which then had an allowable deduction to offset the assessable income that it derived in that year. However, if the company that incurred the interest were to derive a dividend, to the extent that the dividend equalled or exceeded the interest, assuming there were no other income or deductions, there would be no loss in the company and, accordingly, no loss would be available to be transferred to another company in the group (see the First Full Court at [14]).

26. If, in a particular year, a company both incurred interest and derived income in the form of a dividend, it would be necessary to deduct the amount of the interest from the amount of the dividend in order to determine whether there was a profit for company law purposes, from which the company could declare a dividend. If the interest equalled or exceeded the dividend, the company would not be able to declare and pay a dividend, because it would have no profits in that year. Further, if the dividend received by the company was franked and, because there were no profits, the company that received the dividend could not itself declare and pay a dividend to its shareholders, the benefit of the franking credit would be lost. However, as a matter of company law, it was not necessary for a company to make good the losses of previous years before it could be said that the company had a profit out of which it could declare and pay a dividend. Thus, a company with accumulated losses that received a dividend in the current year, assuming the company did not incur interest equal to or greater than the amount of the dividend, could declare a dividend. A group company to which losses were transferred for taxation purposes would not be required, for company law purposes, to take those losses into account when determining whether it could pay a dividend out of profits. As a matter of company law, a company with profits, but tax law losses, could declare and pay a dividend to its shareholders (see the First Full Court at [15]-[16]).

27. It follows from the above that there would be a loss of the tax rebate where a company borrowed at interest to acquire dividend producing shares. In such circumstances, there could be no loss in the company available to be transferred to another company in a group, because the interest deduction would be offset by the dividend received. To the extent that the dividend received was franked, the company would have no ability to declare a dividend so as to pass the benefit of the franking credit through intermediate companies to an individual shareholder, because it would have no profits, for company law purposes, in the absence of any other income (see the First Full Court at [17]).

28. In any given year, there may be intermediate holding companies in a corporate group that incur accounting losses, notwithstanding that their subsidiaries were profitable and able to pay dividends. Such accounting losses usually arose because the intermediate holding company had borrowed to acquire equity in, or lend money to, the subsidiaries, which used the funds to acquire income producing assets.

29. Where the underlying assets had not yet produced sufficient income to service borrowings or to pay dividends, the intermediate holding company would sustain a loss represented by interest on the borrowings. Consequently, the intermediate holding company's financial statements and accounts might show it as having a net asset deficiency, meaning that it had no accumulated profits available from which to declare a dividend. Such an intermediate holding company was referred to as a dividend trap , because dividends paid to it by profitable subsidiaries could not be passed on to the shareholders of the intermediate holding company until such time as it became solvent and had a fund of distributable profits available.

Schemes to reduce income tax: Part IVA

30. Part IVA of the Assessment act is concerned with schemes to reduce income tax. A scheme includes any agreement, arrangement, understanding, promise or undertaking, whether express or implied, and whether or not enforceable, or intended to be enforceable, by legal proceedings. It also includes any scheme, plan, proposal, action, course of action or course of conduct.

31. Section 177F provides for cancellation of tax benefits. Where a tax benefit has been obtained by a taxpayer in connection with a scheme to which Part IVA applies, the Commissioner may, in the case of a tax benefit that is referable to a deduction, determine that the whole or part shall not be allowable to the taxpayer in relation to that year of income and, where the Commissioner makes such a determination, he shall take such action as he considers necessary to give effect to that determination.

32. Section 177C(1) provides that a reference in Part IVA to the obtaining by a taxpayer of a tax benefit in connection with a scheme is to be read, relevantly, as a reference to 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.

33. Under s 177D(b) of the Assessment Act, Part IVA applies to any scheme, where a taxpayer (the relevant taxpayer ) has obtained a tax benefit in connection with the scheme and, having regard to:

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.

34. In order to avoid the consequence that the operation of Part IVA of the Assessment Act might depend upon the fiscal awareness of a taxpayer, the application of s 177D turns upon objective matters set out in s 177D (see
FCT v Consolidated Press Holdings Limited (2001) 207 CLR 235 at 264). Thus, the eight factors set out in s 177D(b) as matters to which regard is to be had in determining dominant purpose are posited on objective facts. The phrase "it would be concluded that" indicates that a conclusion as to the dominant purpose of a person who entered into or carried out the scheme must be the conclusion of a reasonable person (see
FCT v Spotless Services Limited (1996) 186 CLR 404 at 421-2).

35. In arriving at a conclusion for the purposes of Part IVA, the Commissioner must have regard to each of the factors referred to in s 177D(b). However, that does not mean that each of them must point to the necessary purpose; some of the matters may point in one direction and others may point in another direction. The evaluation of all of the factors, either alone or in combination, is required by s 177D(b) in order to reach the conclusion to which s 177D refers (see
Peabody v FCT (1993) 40 FCR 531 at 543).

Takeover of the IEL Group by the Adsteam Group

36. A significant aspect of the present dispute is concerned with the consequences of the merger, by takeover, of the IEL Group of companies with the Adsteam Group of companies. It is therefore desirable first to say something about the two groups and the takeover.

The IEL Group

37. IEL was incorporated in Victoria in 1964. IEL and its subsidiaries ( the IEL Group ) underwent a dramatic growth in the period from 30 June 1974 to 30 June 1987. For example, the consolidated net profit of the IEL Group after tax rose from $1.1 million for the year ended 30 June 1974 to $230.116 million for the year ended 30 June 1987. The number of companies in the IEL Group rose from 117 as at 30 June 1974 to 591 as at 30 June 1987. The total number of employees of the IEL Group rose from 850 as at 30 June 1974 to 23,000 as at 30 June 1987. Finally, average shareholders funds of the IEL Group as at 30 June 1974 were $8.9 million, whereas, by 30 June 1987, average shareholders funds were $1,007.9 million.

38. In the period from 1974 to the end of 1989, most of the investment activity within the IEL Group was directed towards delivering high returns to its shareholders. That object was achieved through the active pursuit of the acquisition of external companies that would deliver a steady income and dividend stream. By the late 1980s, IEL was almost entirely reliant for income and returns to its shareholders upon the dividend stream flowing up from its subsidiaries. IEL itself had ceased to play any direct role in investments. However, IEL had fairly significant operational expenses, including the payment of directors' fees, head office salaries, rent and other expenses. By the end of 1989, the IEL Group operated major businesses and chains such as Woolworths, Big W, Dick Smith Electronics and Mac's Liquor and included businesses operated under well known Australian trade and brand names such as Yates, Hortico, Glad, Pura Milk, Simplicity Funerals and Mason Gray Strange Auctions.

39. From around 1976, the fund of profits available within the IEL Group from which dividends could ultimately be paid up to IEL's shareholders was calculated on an ad hoc basis from company records, including trial balances and company accounts. Depending upon the requirements of IEL in any given year, which were estimated from budget forecasts and trial balances, the dividends that needed to be paid by subsidiaries up to IEL to meet those requirements were calculated and incorporated into dividend recommendations, which were accepted by the boards of the relevant subsidiaries. From about 1985, a more systematic approach to the review of dividend recommendations was adopted as part of the overall trial balance review process.

40. IEF was incorporated in 1981 and, in 1985, commenced acting as an in-house finance company for the IEL Group. One of the objects for establishing an in-house finance company was to simplify group borrowings through one company. It was considered that that would also make it easier to manage the on-lending of funds within the IEL Group. From 1985 onwards, IEF lent funds to other members of the IEL Group at interest. By 1986, the majority of external borrowings by the IEL Group were by IEF. By 1987, IEF's external borrowings were approximately $2.3 billion out of total borrowings of the IEL Group of approximately $3 billion. The majority of loans made by IEF were to other members of the IEL Group. By 1987, IEF had made loans to other members of the IEL Group of sums exceeding $1.95 billion.

The Adsteam Group

41. In the early 1980s, each of The Adelaide Steamship Company Limited ( Adsteam ), Tooth & Co Limited ( Tooth ) and David Jones Limited ( DJL ) was a public listed company. In late 1980 and early 1981, Tooth was the subject of a successful partial takeover by Adsteam. At that time, DJL was an associated company of Adsteam. It is convenient to refer to Adsteam, Tooth and DJL collectively as the Ultimate Parent Companies and to refer to the Ultimate Parent Companies and their respective subsidiaries collectively as the Adsteam Group.

42. A feature of the Adsteam Group was the large cross-shareholdings between the Ultimate Parent Companies themselves, and other associated companies in the Adsteam Group. Thus, as at 30 September 1989:

As at 30 September 1990, similar holdings existed although the proportions had changed marginally. The Ultimate Parent Companies had a policy of participating in dividend reinvestment plans offered by the others. That enabled each of the Ultimate Parent Companies to pay large dividends while not substantially draining cash resources. It also enabled them to increase their shareholdings in each other.

43. By June 1989, the Adsteam Group was a major industrial enterprise, with wholly owned operations, joint ventures and substantial investments in associated companies carrying on business in a broad range of industries in Australia and overseas. The Adsteam Group operated or had substantial interests in businesses in the food, meat, wine and smallgoods, retailing, timber and building, towage and port services, manufacturing, real estate, import and distribution sectors. The businesses included many conducted under well known brand and trade names. Significant investments included holding, directly or indirectly, large investments in the major Australian trading banks, which provided large franked dividends, which the Ultimate Parent Companies were able to pass on to their shareholders. The Ultimate Parent Companies shared a common objective of maximising dividends to shareholders.

The Dextran takeover

44. By 14 November 1989, the Adsteam Group and its associates had acquired 17.63% of the issued shares of IEL. The decision was then taken to launch a takeover bid for IEL. The acquisition was to be largely debt funded. For that reason, it was not considered appropriate to use a wholly owned subsidiary of any one of the Ultimate Parent Companies as the takeover vehicle, because the increased debt would have been too great for any one of them to carry. Dextran Pty Limited ( Dextran ), which was owned as to one-third by subsidiaries of each of the Ultimate Parent Companies, was chosen as the vehicle for the takeover. The debt funding would therefore be spread across Adsteam and its subsidiaries, Tooth and its subsidiaries and DJL and its subsidiaries.

45. On 14 November 1989, Dextran announced a cash offer for the 82.7% of the issued capital of IEL to which it was not already entitled. The press release stated there was no minimum level of shareholding that Dextran proposed to acquire. On 15 November 1989, Dextran acquired further shares in IEL and, as a consequence, Dextran's shareholding in IEL was then slightly more than 50%.

46. On 21 November 1989, following Dextran's obtaining control of the IEL Group on 15 November 1989, Mr John Spalvins, the Managing Director of Adsteam, Mr Michael Kent, the Finance Director of Adsteam, Mr Trevor Thiele, the Group Financial Controller of Adsteam, Mr Rodney Mewing, a director of DJL, Mr Robert Wright, a director of Tooth, and Mr George Haines, a director of Tooth, were appointed to the board of IEL. In February 1990, Mr Spalvins became executive chairman of IEL and Mr Kent deputy chairman. Thus, by that time, the board of IEL consisted of twelve directors, of whom six were Adsteam Group directors. As executive chairman, Mr Spalvins had a casting vote on the board.

47. Dextran's takeover offer closed in March 1990, by which time Dextran was entitled to more than 90% of the issued shares in IEL. On 18 April 1990, the National Companies and Securities Commission ( the Commission ) granted modifications of the Companies (Acquisition of Shares) (Victoria) Code to enable Dextran to proceed to compulsory acquisition of the shares in IEL that it did not already hold. That decision was taken in light of Dextran's ownership of in excess of 92% of the issued shares of IEL. Dextran then made an unconditional offer for the remaining shares and, by late 1990, IEL was a wholly owned subsidiary of Dextran.

48. The IEL Group was regarded as part of the Adsteam Group although, because of the structure of Dextran, no member of the IEL Group was a subsidiary of any of the Ultimate Parent Companies. While the Taxpayers are all members of the IEL Group, it is necessary to have regard to the corporate structure that resulted from the takeover of IEL by Dextran, since that was a significant factor in the conduct of the affairs of the IEL Group after the takeover.

The Spassked dividend trap

49. By late 1986 or early 1987, officers of the IEL Group considered that, if the IEL Group did not change the way that it funded its subsidiaries, its debt lines would become even more complex. Internal restructure of the IEL Group was therefore thought to be necessary. To that end, various officers of IEL consulted with directors, employees and external advisors of the IEL Group and, in about mid-1987, a proposed structure was formulated ( the Spassked Structure ).

50. The Spassked Structure involved the following:

51. Other proposals were considered, but the Spassked Structure was thought to be the most effective for dealing with issues of concern because it:

52. The Spassked Structure was implemented as follows:

53. The amounts borrowed by Spassked remained owing throughout the 1991, 1992, 1993 and 1994 Years and accrued interest. Seven annual amounts of interest totalling $3,272,715,111 were capitalised over the years of income ended 30 June 1988 to 1994 inclusive. By a series of repayments from July 1990 to June 1994, Spassked repaid the borrowings to IEF, using funds lent to it by GIH and IEL on an interest free basis. That resulted in the elimination of the Spassked dividend trap.

The taxpayers' appeal statements

54. The Taxpayers contend that, in the 1991, 1993 and 1994 Years, when Spassked incurred interest expenses and made interest payments to IEF, it was the intention and expectation of the directors of Spassked that dividends would be paid by GIH to Spassked at the earliest available opportunity. They also say that there was the potential for such dividends to be paid. They contend that, by late 1991, when a policy of liquidation of the IEL Group was adopted, it was inevitable that Spassked would receive from GIH either unfranked dividends or other assessable distributions approximately equal to, or greater than, the interest expenses it claimed as deductions. They say that, in the 1991, 1992 and 1994 Years, Spassked had an expectation that the incurring of the interest expenses to IEF would ultimately produce assessable income in the form of dividends or assessable distributions from GIH, in which it had invested the borrowings that generated the liability for interest.

55. The Taxpayers say that a deduction was allowable under the first limb of s 51(1) because of the expectation and intention that dividends would be paid, albeit in the long term, even if GIH would not have made, or was unlikely to have made, distributions to Spassked until Spassked had transferred out all of its accumulated losses to other members of the IEL Group. They contend that the borrowed funds, on which the interest was payable, were, in the 1991, 1993 and 1994 Years, being used for an income producing purpose, namely, the derivation of dividends in the future on the shares acquired with the borrowed funds: the mere deferral of income for a period of seven years from 1990 to 1997 did not mean that the interest expenses were non-deductible.

56. There is considerable overlap in the specific assertions made by the Taxpayers in their respective appeal statements. They begin by referring to the Spassked Structure, and refer to an unfranked dividend of $29,308,093 paid by GIH to Spassked on 30 June 1990 and a further unfranked dividend of $14,654,046 paid to Spassked on 8 October 1990. They also refer to a consolidated fund of profits in GIH and its subsidiaries as at 30 June 1991, of $1,338,749,042, 95% of which was unfranked and was, they say, therefore capable of being distributed only to Spassked. It is convenient to summarise all of the assertions made by the Taxpayers in order to explain the case.

57. QTH asserts that, in the circumstances relevant to the 1991 Year, the intentions and expectations of IEL, Spassked and GIH were relevantly those of the Ultimate Parent Companies. IEF and Spassked also assert that, in the circumstances relevant to the 1993 Year and the 1994 Year, the intentions and expectations of IEL, Spassked and GIH were relevantly those of the Ultimate Parent Companies. QTH relies on the acquisition of shared control of IEL by the Ultimate Parent Companies through Dextran. IEF and Spassked rely on that fact and also point to the following additional circumstances to support their assertion in relation to the 1993 and 1994 Years:

58. The Taxpayers point to the fact that the takeover of IEL by Dextran was financed by funds borrowed both by Dextran and by subsidiaries of the Ultimate Parent Companies. In the 1991 Year, Dextran and those borrowers had continuing financial obligations in relation to those borrowings. They required significant funds in order to meet their financial obligations as well as to pay dividends to the shareholders of the Ultimate Parent Companies.

59. Prior to the takeover of IEL by Dextran, the IEL Group had a different dividend policy from the Ultimate Parent Companies and paid a significantly lower proportion of group profits to its shareholders than did the Ultimate Parent Companies. The Ultimate Parent Companies intended and expected that a proportion of the consolidated profits of the IEL Group would be included in their respective consolidated profits to ensure that appropriate returns on the investment in IEL were shown in their financial statements. They also intended and expected that they would pay dividends to their shareholders that reflected the consolidated profits of the IEL Group.

60. However, a change in accounting standards meant that consolidated profits of Dextran and the IEL Group could not be included in the consolidated profits of the Ultimate Parent Companies unless dividends were paid by IEL to Dextran and then by Dextran to its shareholders, being subsidiaries of the Ultimate Parent Companies. Accordingly, IEL was aware that the Ultimate Parent Companies desired it to pay dividends equating to all or substantially all of its consolidated profits to Dextran, so that Dextran could pay dividends to its shareholders, thereby enabling the Ultimate Parent Companies to include the profits of IEL in their consolidated financial accounts.

61. In the 1993 Year and the 1994 Year, the Adsteam Group was in "liquidation mode". The asset realisation programme, commenced in part by reason of pressure from the Adsteam Group's lenders, was being implemented. Thus, it was clear, by the 1993 Year, that the sale of all the major assets held by the Adsteam Group would proceed and it was the intention of the Adsteam Group, in the 1993 Year and the 1994 Year, that most, if not all, of the assets of the IEL Group, including the business and assets owned by subsidiaries of GIH, would be sold.

62. The principal assets of the Adsteam Group were sold during the 1993 Year and the 1994 Year. Those sales were undertaken with a view to applying the proceeds of sale in payment of the borrowings of the Adsteam Group. IEF and Spassked say that it was intended that the proceeds of sales be distributed up through the IEL Group and ultimately to the Ultimate Parent Companies and that a distribution of profits and a return of the capital of the liquidated subsidiaries would occur as soon as possible.

63. The Taxpayers say that it was an inherent part of the proposals being considered and implemented in relation to the liquidation project that the funds available within GIH and its subsidiaries would flow to Spassked by way of dividends and liquidation distributions, following elimination of the Spassked dividend trap. In the 1993 Year, the Adsteam Group were aware that Spassked continued to be a dividend trap, but intended to eliminate the dividend trap, thereby removing the barrier to Spassked receiving dividends and enabling Spassked to earn significant assessable income as a result of the liquidation of GIH and its subsidiaries. Thus, they say, steps were taken from 30 June 1992 that significantly reduced the size of the Spassked dividend trap, which was eliminated as at 1 July 1994.

64. The Taxpayers also rely on the existence of an ongoing tax dispute with the Commissioner, concerning the availability of losses for transfer by Spassked, as precluding the distribution of significant assessable income to Spassked in the course of liquidating GIH and its subsidiaries. They say that, at all material times, it was the intention of the Adsteam Group that, when the tax position of GIH and its subsidiaries was determined, the profits available for distribution would be distributed to GIH by its subsidiaries and GIH would pay dividends to Spassked and IEL in accordance with the rights conferred by the A Class shares and the B Class shares. By 30 June 1994, the consolidated fund of profits of GIH and its subsidiaries had grown to a sum in excess of $3,000,000,000. They say that in excess of 95% of those profits were unfranked and were therefore only capable of being distributed to Spassked. However, notwithstanding the elimination of the dividend trap in Spassked, the directors of GIH and its subsidiaries were not able to determine conclusively the quantum of profits in those companies from which it would be possible to pay a dividend to GIH and then to Spassked, IEL and Dextran. That was because of the uncertainty raised by the tax dispute with the Commissioner as to the availability of Spassked's tax losses.

The evidence and the witnesses

65. The evidence in each of the Current Proceedings was the same. It consisted of statements of agreed facts and affidavit evidence from officers and former officers of and advisers to the Taxpayers and related or associated companies in the IEL Group and the Adsteam Group. The Taxpayers also tendered substantial documentary evidence and the Commissioner also relied on substantial documentary evidence. Before dealing with the facts in detail, it is desirable to say something about the witnesses. Their evidence in chief was given by affidavit. Some of the witnesses were cross-examined on behalf of the Commissioner and part of the documentary material relied on by the Commissioner included affidavit evidence and cross-examination of a witness in the Earlier Proceeding. The Current Proceedings have been conducted on the basis that all relevant witnesses have been called and were available for cross-examination.

66. There is no real dispute as to the primary facts that are relevant to the questions in issue in the Current Proceedings. Rather, the dispute is concerned with the conclusions that should be drawn from the primary facts. Accordingly, no significant question of the credit of witnesses arises for determination, except possibly in relation to Mr Ross Daniels, to whom reference is made below. That is not to say, however, that the whole of the affidavit evidence should be accepted literally.

67. Mr John Spalvins was a director of Adsteam from July 1979 until July 1991. He was appointed Managing Director in 1981, a position that he held until July 1991. In September 1980, Mr Spalvins was also appointed Chief Executive Officer of DJL and, in February 1981, he became a director and was subsequently appointed Chairman of Tooth. He held his offices in DJL and Tooth until July 1991. During his time in those offices, Mr Spalvins was involved in a significant number of corporate takeovers, some of which were hostile. In the latter cases, it was not possible to perform in-depth investigations in respect of target companies before making a takeover bid. The takeover bid for IEL was such a case. Mr Spalvins' philosophy during that period was to assume control of the target company by appointing, as directors of the target company, people who were directors of companies in the Adsteam Group. It sometimes took some months for new directors to become aware of potential problems within the businesses and structures of the target company.

68. Mr Brian Eggert has worked in accounting, treasury and advisory roles within a number of Australian companies, banks and professional services firms since 1968. In December 1986, Mr Eggert commenced employment with IEL as Group Treasurer. As Group Treasurer, Mr Eggert reported to Mr Rodney Price, who was then the Chief Executive Officer of IEL. Mr Eggert was responsible for overseeing the central treasury function of IEL and its subsidiaries and for ensuring that all companies in the IEL Group had sufficient cash and standby facilities to meet its financial obligations. One of his principal responsibilities was to manage IEL's relationship with its external lenders and to negotiate the terms of facilities granted to IEL by those lenders.

69. In July 1990, Mr Eggert was appointed to the board of IEL and became the Finance Director of IEL. In that capacity, he was responsible for managing the cash flows and dividend flows from IEL and its subsidiaries, including Woolworths. He was also responsible for the formulation and implementation of financial policies and controls relating to all of IEL's financial activities. His areas of responsibility included taxation affairs and ensuring compliance with taxation laws.

70. Mr Eggert ceased employment with IEL in December 1992. However, he continued to be involved with the IEL Group in a consultancy role for a further six months. He worked with the chief executives of three of IEL's major businesses, assisting to prepare those businesses for sale.

71. Mr Ross Daniels joined IEL in early 1974 as its Management Accountant. From 1982 to 1994, Mr Daniels held various company directorships and carried out various management and accounting roles within the IEL Group. He ceased to be an employee of IEL on 30 June 1994 but was retained as a consultant several months later. From late 1994 to approximately the end of 1996, Mr Daniels assisted with the liquidation of companies in the IEL Group. He was also involved in the sale of assets of the IEL Group. Since 1996, the role of Mr Daniels in the IEL Group has been limited to dealing with ongoing disputes with the Commissioner.

72. Mr Daniels was primarily responsible for the Spassked Structure and its implementation. The Taypayers relied on two affidavits sworn in the Current Proceedings by Mr Daniels. The Commissioner did not require Mr Daniels for cross-examination on those affidavits, although he was available for cross-examination. Mr Daniels also gave evidence in the Earlier Proceeding and was cross-examined on behalf of the Commissioner in the Earlier Proceeding. The affidavit evidence of Mr Daniels in the Current Proceedings is substantially to the same effect as his affidavit evidence in the Earlier Proceeding. The transcript of the cross-examination of Mr Daniels in the Earlier Proceeding was tendered in the Current Proceedings by the Commissioner and admitted without objection.

73. The Taxpayers contend that the evidence given by Mr Daniels in the Earlier Proceeding is consistent with his affidavit evidence in the Current Proceedings and with the evidence of the other witnesses called by the Taxpayers in the Current Proceedings. Accordingly, the Taxpayers say, if the Commissioner suggests that there is any inconsistency between the evidence given by Mr Daniels in the Earlier Proceeding and his affidavit evidence in the Current Proceedings, it was incumbent upon the Commissioner to put the suggested inconsistency to him in cross-examination, thereby giving him the opportunity to explain any perceived inconsistency.

74. The Commissioner contends that the purposes and expectations held with respect to the borrowings by Spassked from IEF, as acknowledged by Mr Daniels in his oral evidence in the Earlier Proceeding, can be relied upon by the Commissioner in the Current Proceedings. The Commissioner says that the affidavit evidence in the Current Proceedings does not detract from the acknowledgments given by Mr Daniels in the course of his evidence in the Earlier Proceeding and that those acknowledgments were reflected in the findings made in the Earlier Proceeding, which were confirmed by the First Full Court. The Commissioner says that, in those circumstances, it was not necessary to cross-examine Mr Daniels in the Current Proceedings.

75. Mr Graham Libbesson was, at relevant times, a partner of the chartered accounting firm now known as Pannell Kerr Forster ( PKF ), formerly known as Bowie Wilson Miles & Co. Throughout the 1980s and 1990s, PKF was the tax agent for, and provided advice to, the IEL Group. From 1983 to 1999, Mr Libbesson had regular meetings with Messrs Daniels and other officers of the IEL Group. During that period, Mr Libbesson attended meetings at IEL's offices approximately once a week. During the course of those meetings, Mr Libbesson provided advice in relation to a range of tax issues or factual issues relating to tax issues. In relation to significant issues or transactions, the IEL Group often sought tax advice from external tax advisers. Mr Libbesson was often involved to ensure that external tax advice was sought when required and that the advisers were adequately briefed as to the relevant facts.

76. Mr Robert Wright is a certified practising accountant. From 1974 to 1980, he was employed as an accountant by Tooth. In 1980 he was appointed Chief Financial Officer of Tooth. In 1985, Mr Wright ceased to be Chief Financial Officer of Tooth and in September 1985 he was appointed a director of Tooth, although he continued to be a full time employee of Metro Meat (Holdings) Limited, which was owned by Adsteam and Tooth. Mr Wright remained as a director of Tooth until November 1995. He was a director of DJL from February 1990 to November 1995 and of Adsteam from August 1991 to November 1995. He was a director of Dextran from May 1990, of IEL from November 1989, of Spassked from June 1991 and from GIH from June 1991. He ceased to be a director of all four companies in November 1995.

77. Mr David Ryan is a certified practising accountant. His involvement with the IEL Group began in 1982 in his capacity as an executive of Bankers Trust Australia Limited ( Bankers Trust ). As Bankers Trust was a lender to IEL, Mr Ryan had occasion to deal with IEL personnel in relation to the borrowings by the IEL Group. From May 1992, Mr Ryan was employed by IEL as General Manager (Special Projects). From that time, he was, in effect, the in-house investment banking adviser to the Adsteam Group. He had responsibility for resolving issues relating to liabilities of the Adsteam Group, other than to external lenders. Mr Ryan was also responsible for implementing the IEL business plans. In June 1994, Mr Ryan became a director of Dextran and, in December 1995, following the resignation of Mr Wright, Mr Ryan became the Chief Operating Officer of the Ultimate Parent Companies and IEL. He continued to oversee the sales of assets by the companies in the Adsteam Group, including the IEL Group.

78. Mr Michael Kent was appointed secretary of Adsteam in 1980 and became finance director of Adsteam in 1983. In November 1983, he became a director of Tooth and, in May 1985, he became a director of DJL. In June 1988, he became a director of Dextran. Mr Kent resigned as a director of Adsteam, Tooth, DJL, Dextran and IEL in November 1991.

79. Mr Trevor Thiele became Group Financial Controller of Adsteam in June 1987. He continued in that role until March 1992. He reported to Mr Kent until Mr Kent's resignation in November 1991. On 21 November 1989, Mr Thiele was appointed as a director of IEL. Mr Thiele was also appointed as a director of major operating subsidiaries of IEL, as a representative of the Adsteam Group.

80. As Group Financial Controller of Adsteam, Mr Thiele's responsibilities included ensuring that the reported profit of Adsteam was as high as possible, within the constraints of applicable accounting standards. In his role as Group Financial Controller of Adsteam, Mr Thiele communicated regularly with his counterparts in Tooth and DJL, to address finance issues affecting the Adsteam Group as a whole. After the takeover of IEL by Dextran, the meetings included representatives of IEL.

The detailed facts

81. In order to explain the circumstances that gave rise to the dispute between the Commissioner and the Taxpayers, it is necessary to say something about the position of IEL before the takeover by Dextran. It will be necessary to explain the operation of the Spassked Structure and the concatenation of circumstances that led to financial difficulties for the Adsteam Group and the IEL Group. In particular, it will be necessary to consider the position of Spassked as a dividend trap together with the consequences of that position, and the process of liquidation that was begun following the financial difficulties.

IEL before the takeover

82. The main focus of head office staff of the IEL Group from the mid-1970s until the takeover by Dextran was in supporting or facilitating ongoing investments or acquisitions by IEL. Investments were decided upon by a team within IEL (the Investment Team ). The Investment Team met regularly from 1974 until 1990 to discuss investments and investment strategy. Head office staff were responsible for financing and structuring the companies that were to be used for investments being considered by the Investment Team. From about 1976, Mr Daniels became involved in that process, and from the early 1980s, Mr Daniels became principally responsible for that investment support function. Mr Daniels was also involved in the process of calculating the fund of profits available from which dividends could be paid to IEL's shareholders.

83. In 1983, the Deputy Managing Director of the IEL Group, Mr Goward, formalised the administrative process that backed up the investment process by instituting regular administration and planning meetings of those involved ( the Administration Team ). Mr Daniels was a member of the Administration Team, together with Mr Goward and the IEL Group Company Secretary, the Planning and Administration Manager, the Financial Controller, the Treasurer and the Financial Accountant. The focus of the Administration Team was on supporting the Investment Team.

84. In the late 1970s, Mr Daniels also became involved in the tax matters of the IEL Group. Over the following years, he developed an understanding of the basic elements of Australian corporate law. When he first became involved, the IEL Group's tax affairs were relatively straightforward and tax matters took up only a minor part of his time. However, as the IEL Group expanded in the late 1970s and early to mid 1980s, it became apparent to Mr Daniels that he had neither the time nor the expertise to manage corporate tax issues for a group of the size and complexity that the IEL Group had become.

85. In March 1984, Mr Stephen Latham, a chartered accountant, was employed by the IEL Group. Mr Latham originally assisted Mr Daniels and gradually assumed management of the tax affairs of the IEL Group. Initially, Mr Latham reported to Mr Daniels and thereafter consulted with him regularly about the tax affairs of the IEL Group. Mr Latham's role broadened into one of assisting Mr Daniels with managing the more complex management accounting and planning issues and the development of structured finance proposals. In June 1987, Mr Greg Cottam, a chartered accountant, joined IEL as another tax manager. Both Mr Cottam and Mr Latham continued to consult with Mr Daniels regularly on taxation matters, particularly where such matters were likely to impinge upon the corporate or financial structure of the IEL Group.

86. From about 1985, Mr Daniels conducted biannual meetings with the other members of the Administration Team. The meetings generally coincided with the preparation of accounts for IEL and its subsidiaries in May and December of each calendar year to coincide with the statutory year end and half yearly accounts. The matters discussed at the meetings included the equity and debt structure of each company, as well as the ability of each company to pay a dividend.

87. Following the introduction into the Assessment Act in 1984 of the company tax loss grouping provisions, the commercial value of tax losses assumed a greater significance, since losses could be transferred between wholly owned companies within a corporate group. From 1984 onwards, where a company in the IEL Group had tax losses in any year, those losses were transferred, where possible, to other companies in the IEL Group. Priority was given to the transfer of tax losses out of those companies that were expected to receive dividends in the following year, so as to reduce what was perceived as a wastage of tax losses in that company upon the receipt of a dividend. That was a primary consideration in the dividend recommendation process in which Mr Daniels was involved.

88. Following the introduction of the dividend imputation system into the Assessment Act in 1987, companies that paid franked dividends were rated more highly by shareholders than those that did not. Accordingly, Mr Daniels considered that it was essential that IEL have access to a stream of franked dividends from its operating subsidiaries, which it could pass on to its shareholders.

89. The interaction of those two reforms, being the tax loss grouping provisions and the dividend imputation system, caused a change in IEL's financing policy. Thereafter, there was a preference for intra-group equity funding, because the funding of group companies with equity, rather than with debt, improved the flow of franked dividends up to IEL and decreased what was perceived as a wastage of tax losses. That involved reducing the number of dividend traps within the IEL Group. Another advantage of funding a subsidiary with equity rather than with debt was that the need for the subsidiary to make good any accumulated losses from prior years, in order to pay a dividend, was reduced.

90. The structure of the IEL Group did not readily support the flow of dividends up to IEL, even though IEL was still able to pay dividends. In any given year, there were inevitably companies in the IEL Group that incurred accounting losses. Typically, such companies were the intermediate holding companies, which were profitable and able to pay dividends. Such accounting losses usually arose because the holding company had borrowed to acquire equity in, or lend money to, the subsidiary, which used the funds to acquire income producing assets. Where the underlying assets had not yet produced sufficient income to service the loans or to pay dividends, the intermediate holding company would sustain a loss represented by interest on the borrowings. Consequently, the intermediate holding company's financial statements and accounts showed it as having a net asset deficiency, meaning that it had no fund of profits available from which to declare a dividend. Such intermediate holding companies were therefore dividend traps.

91. In early 1987, Mr Daniels and the other members of the Administration Team turned their attention to planning for the introduction of the dividend imputation system. IEL announced to its shareholders that it was its intention to pay franked dividends to those shareholders who wanted to receive franked dividends. However, any franking credits associated with fully or partially franked dividends received by a loss making intermediate holding company would be trapped within the loss making company. Mr Daniels and the other members of the Administration Team were concerned to minimise the incidence of such dividend traps in order to ensure that both franked and unfranked dividends could be passed up to IEL to enable it to meet its operating expenses and to pay dividends.

92. Mr Daniels also understood that, for tax purposes, dividends received by a company had to be applied, first, to offset tax losses incurred or carried forward in a given year. He perceived that the payment of a dividend into a company with available tax losses would result in the wastage of the tax loss, which would reduce the wealth of shareholders of the company. He regarded it as part of his role to endeavour to reduce the incidence of such occurrences. As prior year losses were to be transferred out to other companies in the IEL Group, Mr Daniels' principal concern was with the wastage of current year losses. Because of the operation of the dividend rebate under s 46 of the Assessment Act, dividends received by companies that did not have tax losses were tax free. However, where the recipient of a dividend had available tax losses, the losses had to be offset against dividend income that would otherwise be rebatable, with the effect that, although the company did not have any liability to pay tax in respect of the dividend, the benefit of the s 46 rebate was lost.

The Spassked Structure dividend trap

93. In making decisions about the declaration of dividends within the IEL Group, the fact that a recipient company had losses available to it that could be transferred to other companies in the IEL Group was an important consideration, because the losses had a value and the payment of a dividend to such a company would destroy the value of those losses. The concept of the Spassked Structure emanated from the introduction of the tax loss grouping provisions and the dividend imputation system during the 1980s. An important objective of the Spassked Structure was to prevent lower companies in the corporate structure from being dividend traps, such that the companies beneath GIH should be able to enjoy the full rebate that attached to dividends received by them. That would be achieved by ensuring that those companies did not, at the same time as receiving rebate on dividends, incur interest to IEF. Thus, one of the aims of the Spassked Structure was to relieve companies lower down in the structure of that problem. Spassked was to become the major dividend trap.

94. The Spassked Structure enabled the IEL Group to distribute franked dividends up to IEL without being subsumed in a dividend trap, to maximise the value of the losses available by transferring them to other members of the IEL Group and to distribute unfranked dividends up to GIH without being subsumed in a dividend trap. They were the three major considerations that were materiel in implementing the Spassked Structure. Other matters were considered but were not regarded as critical.

95. Mr Daniels expected that, while Spassked remained a dividend trap, no dividends, whether franked or unfranked, would be distributed to it by GIH. He said that he envisaged that Spassked would derive dividend income but that that would only occur once Spassked had ceased to be a dividend trap. That would not occur whilst Spassked had tax losses of any material amount that could be transferred to other members of the IEL Group. Mr Daniels said that he envisaged that Spassked would commence to derive income once it had ceased to be a dividend trap and once it had transferred out all of its carry forward losses. Mr Daniels also said that he envisaged that the investments within the Spassked Group would be profitable to such an extent that the trading surpluses would be sufficient, within a fair period of time, to enable the debt to be repaid and to enable dividends to flow. He envisaged that Spassked would, at some stage, repay the debt to IEF. He said that, the most likely scenario would be that there would be an accumulation of funds in GIH and the debt would be repaid by a combination of those funds or dividends or both, at a point in time when there was an amount sufficient to repay the debt.

96. Mr Daniels agreed, in cross-examination in the Earlier Proceeding, that, until Spassked ceased to accrue capitalised interest, it would be a dividend trap and that, in order for it to cease to be a dividend trap, either IEF had to stop charging interest or Spassked had to repay its debt to IEF. He accepted that, so long as the debt existed and Spassked was incurring capitalised interest, GIH would not have distributed funds to Spassked by way of dividend. Mr Daniels also agreed that a substantial dividend would not have been paid to Spassked while Spassked still had losses that were available to be transferred within the IEL Group. He said that it was his expectation that Spassked would derive dividend income once it ceased to have losses available to transfer. He accepted that the Spassked Structure, as initially conceived, had as an integral part both the borrowing of funds by Spassked and the capitalisation of interest and that there was nothing as originally conceived that committed the IEL Group as to how or when the Spassked Structure would be wound down. He agreed that, because of the circumstances, it was impossible to make a firm prediction as to when the capitalised interest would be paid.

97. It may have been the case that Mr Daniels, one of Spassked's four directors and a member of the Administration Team, and Mr Cottam, also a member of the Administration Team, may have thought that, because of legal constraints relating to either the fiduciary duty of Spassked's directors or the tax deductibility of interest paid by Spassked, it might prove to be necessary, one day, for some means to be found for Spassked to receive dividends from GIH. However, it was found in the Earlier Proceeding that that fell far short of signifying that the occasion of the incurring of the interest expenses was an expectation of receipt of dividends or that Spassked incurred the interest expenses in carrying on a business for the purpose of receiving dividends from GIH (the Earlier Proceeding at [238]). It was also found that neither Mr Daniels nor Mr Cottam expected that Spassked would receive, or was likely to receive, dividends from GIH (the Earlier Proceeding at [240]). I make the same findings in the current proceedings.

98. Mr Daniels expected that significant dividends would not have been declared to Spassked while it was a dividend trap and while it had losses available to it to be transferred around the IEL Group. That was why no significant dividend had been distributed to Spassked in the years prior to the 1991 Year. That was the reason why dividends would not be paid to Spassked in and after the 1991 Year, for so long as it was still a dividend trap. Dividends would not have been distributed from GIH to Spassked so long as it was a significant dividend trap, which it was up until 28 June 1994, when Mr Daniels left. Thus, the existence of tax disputes with the Commissioner was not a consideration taken into account by Mr Daniels in deciding whether or not dividends should be declared by GIH to Spassked.

99. While Mr Libbesson became aware of the implementation of the Spassked Structure, he did not give advice concerning it. He accepted that it was a feature of the Spassked Structure that Spassked was incurring interest and not deriving income and that it was therefore making tax losses. He also accepted that, if Spassked did derive income, the tax losses would be reduced to the extent that it so derived income. So far as Spassked had carry forward losses from prior years, if it received income in a particular year, it would also lose those carry forward losses to the extent of that income. It was Mr Libbesson's understanding that the Spassked Structure replaced a structure in which there were several companies in the IEL Group that had been incurring interest and receiving rebatable dividends. He understood that the consequence of implementing the Spassked Structure was to locate all of the interest expense that was incurred to IEF in the one entity, namely, Spassked. Mr Libbesson understood that, once the Spassked Structure was implemented, if Spassked itself received dividends, that would result in the loss of any carry forward losses that were available.

100. A number of further findings can be made in the Current Proceedings based on the findings made in the Earlier Proceeding (at [184] and [199]). The findings are as follows.

101. So long as Spassked was incurring an interest liability to IEF or had undistributed losses, it would not receive dividends from GIH. Accordingly, so long as that situation continued, Spassked would not have the necessary income with which to pay the interest accruing on its borrowings from IEF. Those borrowings therefore had to be capitalised. Accordingly, Spassked could be expected to make a loss in each year of the order of the amount of the capitalised interest for that year. Except to the extent that the losses were transferred by Spassked to other members of the IEL Group, they would accumulate in Spassked (the Earlier Proceeding at [199] (4) and (5)).

102. The distribution of dividends to IEL from the subsidiaries of GIH that would derive profits could not occur through Spassked so long as Spassked remained a dividend trap. However, it could occur directly through GIH by reason of IEL's holding of B Class shares in GIH. In the period from 1 July 1988 to 30 June 1994, $33,378,828 in franked dividends was distributed to IEL in that way, representing the total amount of franked dividends received by GIH from its subsidiaries during that period (the Earlier Proceeding at [199] (6)).

103. The derivation of dividend income from GIH did not form any part of the motivation behind the establishment of the Spassked Structure (the Earlier Proceeding at [199](13)). Progressively down to 1998, Spassked transferred to other members of the IEL Group all of its tax losses, amounting to some $3.2 billion. The reason for transferring the losses pursuant to s 80G of the Assessment Act was to reduce the amount of tax that the other members of the IEL Group would otherwise have had to pay (the Earlier Proceeding at [199] (14)).

104. Spassked's directors expected that the subsidiaries of GIH would receive substantial dividend income from their underlying investments. During the 7 years of income ended 30 June 1988, 1989, 1990, 1991, 1992, 1993 and 1994, GIH's subsidiaries received approximately $83.4 million of franked dividends and approximately $1.454 billion of unfranked dividends. Because the subsidiaries had repaid their debts and had no associated interest liabilities, none of those dividends was subsumed in dividend traps at the level of the subsidiaries. GIH paid franked dividends to IEL totalling $33,378,828, being the amount of franked dividends received by GIH from its subsidiaries, and paid to Spassked the two unfranked dividends totalling $43,962,139. That left GIH holding a balance of $182,749,388 of unfranked dividends, which it had received from its subsidiaries and which were available for distribution to Spassked but were not in fact distributed to Spassked. Further, the subsidiaries continued to hold some $50 million of franked dividends and some $1.227 billion of unfranked dividends that, so far as GIH's constitution was concerned, could have been distributed to GIH and then to Spassked and, in the case of franked dividends, to IEL. However, it was not contemplated that there would be any distribution of dividends to Spassked so long as it was a dividend trap and still had transferable losses. (the Earlier Proceeding at [199](15)).

105. Maximising the tax losses was very important to the IEL Group. For example, in the 1991 Year, the total taxable income of the IEL Group was $1,309,955,903, before the transfer of losses. Of that, $162,665,425 represented rebateable dividends. After allowing for the rebateable dividends, the total taxable income was $1,147,685,524, which was reduced to $5,460,747 by the transfer of losses in the sum of $1,142,224,777. Spassked's contribution to those losses was $642,273,167. In the 1993 Year, the total taxable income before the transfer of losses, was $676,949,195. After allowing for rebateable dividends, the taxable income was $430,708,195, which was reduced to nil by the transfer of tax losses. Spassked's contribution to the transfer of losses was $200,917,810. Thus, Spassked's ceasing to be a dividend trap and being a repository of losses went together. If Spassked ceased to be a dividend trap, it would cease to be a borrower and would cease to have interest deductions (the Earlier Proceeding at [199] (15)).

106. It was no part of the planned purpose or expectation of the Spassked Structure that GIH would pay dividends to Spassked. At no time in the latter half of 1987 or at any time from then down to 28 June 1990 was there a motivation, subjective purpose or subjective expectation that GIH would ever pay dividends to Spassked. Neither the directors of Spassked nor the members of the Administration Team discussed any means by which Spassked might ever receive dividends from GIH because to receive dividends was not part of their plan and was inimical to it. There was no good reason why any of them should think about destroying or reducing the utility of the Spassked Structure. At that stage, their hope was that the Spassked Structure would remain in place indefinitely (the Earlier Proceeding at [237]).

107. It may be that Mr Daniels, one of Spassked's four directors and a member of the Administration Team, and Mr Cottam, also a member of the Administration Team, thought that it may prove to be necessary one day, because of legal constraints relating to either the fiduciary duty of Spassked's directors or the tax deductibility of the interest paid by Spassked, for some means to be found for Spassked to receive dividends from GIH. If it did, that might have been capable of achievement by resorting to the funds of GIH to discharge it's indebtedness to IEF. However, that fell far short of signifying that the occasion of the incurring of the interest expenses was an expectation of receipt of dividends or that Spassked incurred the interest expenses in carrying on the business for the purpose of receiving dividends from GIH (the Earlier Proceeding at [238]). Neither Mr Daniels nor Mr Cottam expected that Spassked would receive, or was likely to receive, dividends from GIH (the Earlier Proceeding at [240]).

108. Those conclusions must stand in relation to the position up to 28 June 1990. The question raised in the Current Proceedings, however, is whether the circumstances can be shown to have changed after 28 June 1990, such that a conclusion can be drawn that the interest incurred in the 1991 Year, the 1993 Year and the 1994 Year fell within s 51(1) of the Assessment Act. Before dealing with that question, it is necessary to deal with the detailed facts that are said by the Taxpayers to constitute such a change of circumstances from those prevailing up to 28 June 1990.

The Upstreaming Covenant

109. The IEL Group had in place a significant number of finance facilities with external lenders, including Australian and foreign banks. There were approximately sixty banks and approximately thirty facilities. Many of the facilities were syndicated among a group of banks and other lenders. Most of the facilities were unsecured. However, the lenders were afforded protection through negative pledge arrangements, either as part of the facility agreement itself or under separate negative pledge agreements with relevant lenders. Such arrangements often required the IEL Group to maintain minimum levels of capital funds and limited the total external liabilities of the IEL Group to an amount that was determined by a ratio of liabilities to assets. The ratios were calculated each month and IEL's auditors checked the calculations and incorporated them into a half yearly report to the relevant lenders. Different facilities had different ratios, different reporting requirements and different events of default. That made the monitoring of compliance quite time consuming.

110. Following his appointment as Group Treasurer in December 1986, Mr Eggert considered that it was desirable to simplify and revise the negative pledge arrangements in order to afford the IEL Group greater flexibility, while continuing to provide comfort and protection to lenders. Mr Eggert also wanted to ensure that the facilities would be more flexible with respect to reporting and administrative arrangements. Some months after the stock market crash of October 1987, Mr Eggert engaged Bankers Trust to assist in the development and negotiation of new arrangements with external lenders. By June 1989, a relatively standard form of arrangement was agreed with the lenders and that arrangement was adopted in a number of the existing facilities at that time and over the following months.

111. Accordingly, from late June 1989, all of IEL's facilities included a new restraint ( the Upstreaming Covenant ). The effect of the Upstreaming Covenant was to prevent IEL and any of its affiliates from:

to or from any associate, except for the payment of a dividend on ordinary shares out of trading profits of the current or any subsequent financial year or the disposal or dealing with any asset under a transaction effected on an arms length basis with receipt of full consideration.

The new IEL dividend policy

112. From the time of the takeover of IEL, the directors of the Ultimate Parent Companies required dividends from IEL approximately equivalent to the total consolidated profits of the IEL Group. Such dividends were required for various reasons.

113. The first was to facilitate the continued payment of substantial dividends to the shareholders of the Ultimate Parent Companies. The general policy of the Ultimate Parent Companies was to distribute virtually all profits to their shareholders by way of dividends. For example, in 1990, $202 million of $220 million of group operating profit of Adsteam was distributed by way of dividend, $234 million of $253 million of group operating profit of DJL was distributed by way of dividend and $215 million of $216 million of group operating profit of Tooth was distributed by way of dividend.

114. Secondly , the Ultimate Parent Companies and Dextran needed to service the increased debt incurred as a result of funding the cost of the acquisition of IEL shares. In November 1989, Dextran negotiated a facility to borrow $900 million from a bank syndicate ( the Bank Syndicate ) to fund the purchase of shares in IEL. The total consideration for the acquisition by Dextran of the issued capital of IEL, of $1.8 billion, was to be funded as to $900 million by that facility and as to the balance of $900 million by unsecured subordinated loans from the Ultimate Parent Companies.

115. By April 1990, when settlement of the purchase of shares under the takeover offer was required, alternative funding arrangements were made. The revised financial package consisted of:

The Ultimate Parent Companies or their subsidiaries were required to provide subordinate loans of not less than $400 million to Dextran under the bridging facility before Dextran could draw on its facility.

116. A significant part of the funds provided by the Ultimate Parent Companies to Dextran was sourced from increased borrowings by those companies. As at 30 September 1990, the total borrowings were $1,068 million by Adsteam, $1,487 million by DJL and $1,023 million by Tooth. Accordingly, Dextran required significant funds to meet its obligations under the bridging facility and to meet the needs of its shareholders to assist them to service their increased debt obligations. One of Mr Kent's principal responsibilities was to ensure that Adsteam was in a position to return a high proportion of consolidated net profits to shareholders as dividends. Mr Kent expected that IEL would generate significant profits and, as a result, would be able to pay dividends to Dextran so that, in turn, Dextran would be able to meet its obligations under the financing arrangements and meet the needs of the Ultimate Parent Companies in servicing their increased debt obligations.

117. The third reason was to ensure that the profits of the IEL Group were reflected in the accounts of each of the Ultimate Parent Companies, notwithstanding changes to equity accounting rules. Prior to 1989, each of the Ultimate Parent Companies had adopted the practice of equity accounting. Under that practice, a company would include in its accounts a proportion equal to its shareholding, of the profits derived by another company in which it held shares, being a company that was not a subsidiary. However, during the year ended 30 June 1989, the Australian Accounting Standards Review Board and the Commission issued a statement concerning the use of equity accounting in relation to investments held in associated companies, being companies in which at least 20% but not more than 50% of the issued capital was held. A company could only include in its profits the amount of dividends that it actually received from such an associated company. That change was significant in relation to the Ultimate Parent Companies, because each of them held only a one-third interest in Dextran. Thus, while Dextran was an associated company of each of the Ultimate Parent Companies, it was not a subsidiary. Accordingly, the Ultimate Parent Companies could not bring to account the profits of the IEL Group that were not actually distributed.

118. Finally, it was necessary to ensure that the IEL Group did not breach the Upstreaming Covenant. In early 1990, Mr Eggert told Messrs Spalvins and Kent that, because of the Upstreaming Covenant, the only way that IEL could distribute funds to Dextran was by way of dividends from current year trading profits. Mr Spalvins or Mr Kent asked Mr Eggert whether there was a way around the prohibition in the Upstreaming Covenant. Mr Eggert was asked to ensure that IEL would be in a position to pay as large a dividend as possible from that time onwards.

The deteriorating financial position

119. From about May 1990, Mr Eggert was involved in the preparation of the budgets of the IEL Group for the 1991 Year. He provided information in relation to interest rates and costs and financing information for inclusion in the budget. When the 1991 budget was prepared, the forecast profit for the IEL Group for the 1990 Year was $177 million. That was significantly less than the original budgeted figure of $338 million. In addition, the forecast closing net debt level of the IEL Group at 30 June 1990 had increased to $1,327 million, compared with the original budget of $728 million. The increase was caused by the deferment of asset sales, the purchase of other interests, additional interest payments and dividend payments arising from the change in dividend policy following the takeover by Dextran.

120. The budgeted cash flow for the 1991 Year forecast a reduction in net debt of $177 million during the 1991 Year before asset sales. The cash flow assumed that two dividends totalling $155 million would be paid to Dextran in November 1990 and May 1991, which would have resulted in total dividend payments, in respect of the 1990 Year, equivalent to the IEL Group's forecast net profit for that year.

121. IEL's accounting staff prepared monthly financial reporting packages for incorporation into the monthly board papers. Part of that package consisted of an annual profit or loss forecast for the current year, which was revised each month. The forecast for the 1991 Year deteriorated each month from July 1990 until June 1991. The following table shows the annual forecast profit or loss for each of the months July 1990 to May 1991 inclusive. The actual result for the year ended 30 June 1991 was a loss of $231,431,000.

Month Annual forecast profit/loss
July 1990 $169,974,000
August 1990 $171,695,000
September 1990 $88,937,000
October 1990 $86,108,000
November 1990 $81,489,000
December 1990 $42,898,000
January 1991 $29,000,000
February 1991 ($22,712,000)
March 1991 ($36,697,000)
April 1991 ($270,453,000)
May 1991 ($316,484,000)
June 1991 (actual) ($231,431,000)

122. The overall loss was primarily attributable to losses and write downs sustained by the IEL Group in relation to real property assets and some share investments that were written down or sold at a loss. However, the operating businesses, and in particular Woolworths were trading profitably throughout the 1991 Year. The actual profit of Woolworths of the 1991 Year exceeded the profit forecast that had been made in August 1990.

123. Mr Eggert was of the view, at the time of preparing the 1991 budget in May 1990, that the IEL Group would need to reduce debt through asset sales. By late June 1990, a programme for the sale of assets was identified.

124. By August 1990, IEL was experiencing liquidity problems. Mr Eggert prepared a strategy document at about that time to provide a financial plan suitable for the financing of the IEL Group during the next 12 months. One purpose of the strategy document was to set out the steps being taken to improve IEL's financial position, given the necessity for the IEL Group to persuade its lenders to continue to fund and to increase funding. The steps to be taken by the IEL Group included raising up to $100 million in the credit market and selling businesses and assets to reduce debt.

125. By October 1990, the position had deteriorated. The full year forecast was substantially downgraded to reflect the decline in the property market and the lower values likely to be realised for sales in such a climate. By late October 1990, it was projected that a reduced dividend would be paid to Dextran and, by December 1990, a proposed interim dividend had been eliminated from the forecast. The planned asset sales of $300 million had not been achieved by the end of November 1990. The liquidity crisis and the inability of IEL to achieve substantial asset sales, as contemplated by the 1991 budget, as well as the Adsteam Group's restructuring and debt reduction problem, which required immediate sale of non-core assets, necessitated the consideration of alternative methods of achieving asset sales.

126. On 21 December 1990, Mr Eggert, in his capacity as finance director of IEL, wrote to all of IEL's bankers, providing an update on IEL's financial position. The update began by referring to a recent announcement by the Adsteam Group that it proposed to undertake an asset divestment and restructuring program aimed at rationalising business activities. He told the bankers that, in participating in the proposed asset divestment and restructuring programme, IEL's principal objectives would be to strengthen its cash flow from its retailing operations and to reduce its debt through the sale of assets that were not part of that new retail focus. The achievement of those objectives would include the refinancing of existing loan facilities.

127. In the meantime, the banks that were providing the major portion of IEL's short term debt were to extend the maturity dates for their facilities to 31 December 1991. Mr Eggert said that IEL would retain all surplus funds to enable it to repay debt as and when the debt matured and to provide funds for working capital purposes. He said that, in the meantime, IEL had undertaken that it would not allow certain inter-company transfers to occur. That included a prohibition on the declaration or payment of a dividend, other than the payment of a dividend declared prior to the date of the undertaking and of which the banks had been informed in writing.

128. In a report of 15 January 1991, Mr Eggert stated that the IEL Group was facing a serious liquidity issue. Given that the planned sale of Woolworths and some other of IEL's businesses had not eventuated, IEL needed additional standby facilities to meet funding requirements. Further, it was clear, from the deterioration in the consolidated net profit projection, that IEL would not be in a position to pay a significant dividend for the 1991 Year. That, in turn, meant that the immediate need to pay dividends through Spassked to IEL in that financial year ceased to be an immediate priority for the IEL Group, although Mr Eggert considered that it remained an issue to be resolved. At January 1991, Mr Eggert's attention was focussed almost exclusively on the pressing financial problems that the IEL Group was experiencing and on negotiating with IEL's lenders.

129. In February 1991, Mr Eggert prepared an IEL finance plan ( the February 1991 Finance Plan ) for distribution to the IEL board and to IEL's bankers. The purpose of the February 1991 Finance Plan was to provide a short term plan suitable for the financing of the IEL Group during 1991. In the February 1991 Finance Plan, Mr Eggert described the need to make substantial property write downs and provisions on the remaining investment portfolio. He also discussed the sale of operating businesses to reduce debt. He said that it had been necessary to delay the payment to trade creditors, which had an impact on the IEL Group's business dealings with suppliers. Mr Eggert did not recommend the continuation of such a policy. Despite the immediate liquidity crisis, Mr Eggert believed throughout the 1991 Year that the IEL Group's long term future was sound and that the assets held by the IEL Group exceeded its external debt obligations.

130. The February 1991 Finance Plan suggested, as an interim step, seeking the approval of the IEL Group's bankers for a temporary facility of $100 million to be repaid out of the proceeds of asset sales. In March 1991, IEL was granted such a facility by a group of bankers. That eased the immediate liquidity crisis. In April 1991, IEL requested additional facilities of $80 million to cover ongoing needs.

131. For the year ended 30 June 1990, the consolidated operating profit after income tax attributable to shareholders of IEL was $105,478,000. IEL declared and paid an interim and a final dividend totalling $100,858,000 in relation to the 1990 Year. Dextran received $93,348,000 of those dividends and declared and paid dividends totalling $92,172,000 to its own shareholders in relation to the 1990 Year, that being its total operating profit after tax. The payment of such dividends was consistent with Mr Kent's expectation in relation to the Adsteam Group's investment in IEL. It was necessary to assist Dextran and the Ultimate Parent Companies to meet their increased debt obligations.

132. The consolidated operating profit of IEL for the 1990 Year was significantly lower than the previous year's consolidated profit, of approximately $283 million. It was also less than Mr Kent had expected at the time that Dextran's takeover bid was launched. The decrease was the result of a fall in the value of the IEL Group's assets. For example, in the 1990 Year, IEL made provisions of $133 million for diminution in the value of assets.

133. Mr Kent expected in July 1990 that IEL would again pay a significant dividend to Dextran. However, in subsequent months, as IEL began to revise its forecast annual consolidated profits for that year, the Adsteam Group also revised the forecast quantum of distribution expected from IEL. The assumption that IEL would distribute all of its annual consolidated profit to Dextran and that Dextran would distribute all or almost all of its profits to its shareholders, underlay each revision of the forecast. By December 1990, the Adsteam Group had revised the forecast distribution by IEL to nil, reflecting the declining forecasts of annual consolidated profits by IEL.

134. By late 1990, the financial position of the Adsteam Group had deteriorated and Mr Kent was negotiating with its lenders on various proposals to restructure the Adsteam Group and its borrowings and to reduce the Adsteam Group's debt. The deterioration of the financial position of the Adsteam Group increased the need to distribute funds from the IEL Group.

135. From late 1990, Mr Kent entered into negotiations with representatives of the principal lenders to the Adsteam Group in relation to refinancing and reconstruction proposals. In early 1991, Mr Kent began dealing with Mr David Crawford, of KPMG Peat Marwick, who was engaged by the principal lenders. On 27 March 1991, the lenders and the Ultimate Parent Companies entered into group loan facilities deeds, which were amended in May 1991. The deeds, as amended:

136. In May 1991, BT Corporate Finance Limited ( BT ) was engaged by the Ultimate Parent Companies to prepare a business plan for the Adsteam Group. BT delivered a report to Adsteam in September 1991 setting out such a business plan ( the BT Plan ). Mr Ryan was instrumental in formulating the recommendation contained in the BT Plan that the Adsteam Group, including the IEL Group, undertake a staged realisation of most of their assets while permitting the core businesses to continue trading, meeting liabilities and delivering a return to shareholders, thereby avoiding a fire sale. The BT Plan proposed an extended and flexible workout. Mr Ryan considered that it would be more likely that the optimal price would be secured for the assets if there was no telegraphing to the market that particular assets were required to be sold by a particular time. The BT Plan recommended the disposal of substantially all assets and the repayment of liabilities of the Adsteam Group over time to allow external debt to be repaid. However, it did not recommend the sale, for the time being, of the major retail assets, consisting of the David Jones stores and Woolworths, but suggested that the retention of those assets should be reviewed periodically. The BT Plan also involved a restructuring of debt to external lenders.

137. On 5 September 1991, the directors of the Ultimate Parent Companies considered the BT Plan and adopted it subject to certain conditions. The BT Plan was then released to the Adsteam Group's lenders to seek their agreement to defer enforcement of facilities so as to allow the BT Plan to proceed. Ultimately, the BT Plan was approved by the Adsteam Group's lenders by late 1991. Several syndicated facilities were finalised with the execution of refinancing deeds in December 1991 ( the Refinancing Deeds ), which implemented the debt restructure proposed by the BT Plan.

138. Since the BT Plan was not addressed to, or commissioned by IEL, IEL did not formally approve it. However, the BT Plan contemplated that the assets held by the IEL Group would also be realised over an extended period of time. It also forecast that the Ultimate Parent Companies would receive substantial dividends from Dextran in the years ending 30 June 1994, 1995 and 1996, even on the assumption that Woolworths was not sold.

139. Under the Refinancing Deeds, the Ultimate Parent Companies were required to deliver, to the Adsteam Committee, regular financial statements, as well as a proposed group budget and business plan. If the Adsteam Committee did not notify that it disapproved of the proposed group budget and business plan within a certain period, that plan was taken to be the current budget and business plan for the relevant financial year. The corporate strategy section of the business plan was required to be updated on a quarterly basis. If the Adsteam Committee disapproved of a proposed group budget or proposed business plan, that would constitute an event of default under the Refinancing Deeds.

140. While the basic premise of the BT Plan was that the Adsteam Group's entire portfolio of assets was to be sold, the strategy excluded the sale of Woolworths and the David Jones department store business. Nevertheless, it was always intended that Woolworths, being a significant asset, would be sold at the right time. However, it was difficult at the time of preparing the BT Plan to know when would be the best time.

141. Mr Ryan expected that, after the IEL Group's assets had been sold and its debts repaid, there would be surplus funds to be distributed to Dextran. He prepared the BT Plan on the assumption that IEL would pay to Dextran an annual dividend equal to the operating cash flow that remained after retaining an amount sufficient to cover 1.25 times the IEL Group's projected interest expense. The proceeds from the sale of the assets of the IEL Group would be used to repay IEL debt. When that debt had been reduced to $750 million, all excess cash flow, including proceeds of asset sales, would be available to be paid as dividends by IEL to Dextran until such time as Woolworths was sold. When Woolworths was sold, the proceeds of that sale would be applied in repayment of IEL's remaining debt.

142. The BT Plan did not recommend at any time that there should be dividends paid to Spassked. Mr Ryan pointed out, however, that the BT Plan was presented on a consolidated basis and did not look at individual subsidiaries. He did not agree that a payment by way of dividend to Spassked in, for example, the 1991 Year, would have been contrary to the objectives sought by the BT Plan. However, he accepted that any dividend paid to Spassked in the 1991 Year would have been a payment into a dividend trap and the amount could not be distributed further up to IEL. He accepted that the BT Plan did not contemplate in any way the payment of a dividend into a dividend trap.

143. By April 1991, Mr Eggert believed that all of IEL's external debt would have to be refinanced. Accordingly, he commenced the renegotiation of the IEL Group's facilities, with the assistance of Bankers Trust. The aim of the renegotiation was for the existing lenders to take security over assets held by the IEL Group and to remove the Upstreaming Covenant. Refinancing negotiations resulted in the execution of a multi option facility agreement on 31 December 1991 ( the Multi Option Facility ), which replaced all other existing IEL and IEF facilities.

144. The Multi Option Facility also required IEL to develop a business plan and annual budget setting out the corporate strategy by which its debt under the Multi Option Facility was to be paid in full. The business plan and annual budget was to be provided to the agent for the lenders. If the agent did not notify IEL that it did not disapprove of the proposed business plan and annual budget, it was taken to be the business plan and annual budget for the relevant year. Disapproval was an event of default under the Multi Option Facility.

The Spassked problem

145. Mr Eggert understood that the Adsteam Group expected IEL to pay dividends to Dextran that equated to the annual consolidated profits of the IEL Group. That was required in order to satisfy the Adsteam Group's needs outlined above in dealing with the new IEL dividend policy. In previous years, IEL's policy had been to pay a much lower proportion of its profits as dividends to shareholders. For example, in each of the 1987, 1988 and 1989 financial years, IEL made distributions equivalent to approximately 7%, 15% and 5% of its operating profit after tax respectively. However, for the year ended 30 June 1990, almost all of the consolidated operating profit after tax attributable to shareholders of IEL was distributed to IEL's shareholders, including Dextran.

146. From the date of his appointment as finance director in July 1990, Mr Eggert was responsible for ensuring that all of the operating profits of the IEL Group were paid as a dividend to Dextran. To achieve that end, it was necessary to ensure that profits derived by subsidiaries of IEL were paid by way of dividend to IEL. Mr Eggert was assisted by Messrs Latham and Cottam, who met twice a year with Mr Libbesson to discuss planning issues and determine dividend payments by subsidiary companies.

147. Mr Eggert understood that a very significant part of the operating profits earned by the IEL Group in the 1991 Year would be generated by subsidiaries of GIH, including Woolworths. He understood that, as a consequence, GIH would have to pay the funds to Spassked by way of an unfranked dividend and, in turn, Spassked would have to pay an unfranked dividend to IEL.

148. Mr Eggert also understood, at that time, that Spassked was a dividend trap in the sense that it had significant interest expense each year on its borrowings from IEF, with the consequence that, if it received dividends from GIH, those dividends could not be passed on to IEL because Spassked itself would have no profits for that year. He understood that, if the Spassked Structure remained in place, interest would continue to accrue to IEF on the Spassked borrowings and would be capitalised on those borrowings. That would exacerbate the dividend trap problem by increasing the outstanding debt and therefore the quantum of future interest. Mr Eggert therefore believed that any solution to the dividend trap problem would involve either the repayment, or a substantial reduction, of the Spassked borrowings from IEF.

149. In July or August 1990, Mr Eggert requested Mr Latham and Mr Cottam to consider ways of allowing dividends to be passed through Spassked, by allowing Spassked to repay or substantially reduce its debt to IEF and thereby cease to be a dividend trap. In response, Mr Latham produced a memorandum dated 3 September 1990 ( the September 1990 Memorandum ) addressed to Mr G. Cohen of Rosenblum & Partners ( Rosenblums ), seeking legal advice. A copy of the September 1990 Memorandum was provided to Messrs Eggert, Cottam and Libbesson.

150. The September 1990 Memorandum relevantly provided as follows:

" RE: IEL CORPORATE STRUCTURE

THE PROBLEM

Absolute quantum of interest expense incurred by [Spassked] 1991 $650m; this amount is capitalised and compounds annually to the extent that offsetting (dividend) income is not received from [GIH].

OBJECTIVE

Substantive prior years ($1 bn) and ensure on-going tax deductibility of interest in [Spassked].

ASSOCIATED ISSUES

In line with the size thereof and increased ATO focus a tax audit may challenge the deductibility of the interest for tax purposes.

Existence of the significant carried forward tax losses (in relation to the interest claimed as a tax deduction in prior years) in [Spassked] restricts the flow of (rebatable) dividend income from GIH in order to avoid 'wastage' of such losses.

The consequent creation of a net loss in [Spassked] in each year prohibits the on payment of any dividend from [Spassked] to IEL as there is no fund of current year profits out of which to pay such a dividend.

…

PERCEIVED REQUIREMENTS

  • 1. Continue to action/evidence a regular dividend flow from GIH to [Spassked] (1990 $30m).
  • 2a Reduce the ongoing creation and accumulation of interest deductions/tax losses in [Spassked] so as to permit tax effective dividend flows up-the-chain to IEL.
  • 2b Utilise s 80G tax loss grouping provisions to extinguish c/f losses in [Spassked] in preference to any other 'groupable' losses available…
  • …

PROPOSAL

  • (A) Reduce i/c receivables in all GIH subsidiaries except those where capital losses exist and consequently the requirements of the same business test may need to be satisfied.
  • (B) …
  • (C) …
  • (D) …
  • NB: In view of the apparently satisfactory reviews of the technical/practical aspects to the issues associated with interest deductibility it has been decided not to proceed with the previously proposed Spassked II structure given the possible (albeit remote) Part IVA risk and also the administrative requirements involved.

    Moreover, the previously proposal [sic] asset revaluation dividend from [Spassked] to IEL would only be in the order of $114m which is 'somewhat insignificant in the scheme of things' (and may indeed be subject to some degree of valuation error).

    Consequently, the Spassked II proposed, as discussed does not, in fact, improve the situation."

Mr Eggert did not fully understand the proposals set out in the September 1990 Memorandum. He had a conversation with Mr Latham in which Mr Latham endeavoured to explain to him the proposals in the September 1990 memorandum.

151. Mr Libbesson was aware, during the 1991 Year, that there were problems associated with GIH paying a large dividend to Spassked. Even though there were substantial profits in GIH subsidiaries, the interest expense incurred by Spassked had grown to such an extent that any dividend income from GIH would be offset against that interest expense and Spassked would have had insufficient profits to declare a dividend to IEL. Most of the projected profits from GIH's subsidiaries at that time were unfranked, so that most profits could not be distributed direct to IEL. If GIH paid dividends to Spassked before Spassked had transferred out such tax losses as it had available for transfer to other companies in the IEL Group, that would have resulted in wastage of those tax losses. Mr Libbesson discussed those issues with Messrs Latham, Cottam and Eggert. In the course of those discussions, proposals to eliminate the Spassked debt to IEF were considered, so that dividends could be paid by GIH to Spassked. However, Mr Libbesson was never asked to consider whether arrangements could be put in place to enable GIH to pay dividends directly to IEL.

152. The proposals involved:

Mr Libbesson accepted that the effect of the first two steps would have been to cause Spassked to cease to be a dividend trap, with the consequence that a dividend paid to it could be passed up the chain. However, if it had prior year losses, the losses had to be transferred out if that was going to happen. Mr Libbesson would have advised that, if dividends were paid before the carry forward losses had been utilised, the carry forward losses would have been lost.

153. Mr Libbesson discussed the proposals contained in the September 1990 Memorandum at a meeting, in about September 1990. Mr Libbesson said that one of the objectives discussed at the meeting was the question of tax deductibility but that, just as compelling, if not more compelling, was the ability to pay dividends to IEL. Those at the meeting discussed whether it may be possible to put in place a new structure, under which a new company would borrow from IEF and then use those funds to capitalise Spassked. However, that proposal was not progressed. Mr Libbesson does not remember any discussion of a proposal for dividends to be paid straight from GIH to IEL. The discussion turned on considering the difficulty arising from the fact that a payment of a dividend to Spassked would be a payment into a dividend trap. It was not Mr Libbesson's recollection that it was envisaged by those at the meetings that Spassked should continue to incur interest. The idea of the meeting, he said, was to stop Spassked incurring interest.

154. Mr Thiele understood that, unless steps were taken, the existence of Spassked as a dividend trap could impede the distribution of dividends to IEL and, in turn, distribution from IEL to Dextran. Mr Thiele was informed by Messrs Latham and Cottam that a significant proportion of the current year forecast profits of the IEL Group for the 1991 Year was located in GIH and its subsidiaries. He understood that, if those profits were to be made available to Dextran, dividends would have to be paid by GIH to Spassked, by Spassked to IEL and by IEL to Dextran. Mr Thiele was not aware that IEL B Class shares in GIH.

155. Mr Thiele did not become directly involved in trying to resolve the issues raised by the Spassked dividend trap. He believed that Messrs Cottam and Latham were addressing those issues. However, Mr Thiele was aware, at around the middle of 1990, that either Mr Cottam or another IEL employee produced a memorandum that proposed solutions to the Spassked dividend trap problem. Mr Thiele does not have a specific recollection of the memorandum although it could have been the September 1990 Memorandum. Mr Thiele's recollection is that the memorandum that he saw outlined proposals for the distribution of profits as dividends from GIH and its subsidiaries to Spassked, which would allow Spassked to retire its debt to IEF and pay dividends through IEL to Dextran. In any event, the proposals outlined in the memorandum that Mr Thiele saw had not been implemented before he left in March 1992.

156. Mr Thiele resigned as a director of IEL in July 1990. However, in his capacity as Group Financial Controller of Adsteam, he continued his involvement with IEL personnel in order to ensure that the Adsteam Group's investment in IEL was protected and that profits and dividends were maximised. As part of that process, IEL was required to provide the Adsteam Group with monthly reports and forecasts of the consolidated operating profits, broken down into trading profits by sector, out of which dividends could be paid. As most of the forecast profits would be earned from companies in the Spassked Structure, such as Woolworths, dividends would be required to pass though GIH and Spassked to IEL in order to allow IEL to pay a dividend to Dextran. At that time, Mr Thiele did not take any steps to determine for himself what the shareholding structure of GIH was.

157. Mr Wright learned of the existence of the Spassked dividend trap prior to 16 May 1990. He understood that the dividend trap could be a particular problem in the 1991 Year and subsequent years because a large proportion of the IEL Group consolidated operating profit that was projected to be made during the 1991 Year was to be made by companies that were subsidiaries of GIH. He understood that, as most of the projected profits in the GIH subsidiaries would be unfranked, the profits could only flow to IEL by way of Spassked. Mr Wright considered, therefore, that it was essential that the Spassked dividend trap be removed in order to allow the current year operating profit of the GIH subsidiaries to be distributed through the chain of companies to GIH, Spassked, IEL and then Dextran. Mr Wright accepted that the circumstances of Spassked at that time meant that any payment of a dividend to it would have created a difficulty because the objectives of the Dextran directors were to receive dividends and payment into Spassked would mean that those dividends would not flow through the Group to Dextran.

158. Mr Wright accepted that, while Spassked was a dividend trap, it prevented the flow of dividends and, for that reason, dividends would not be paid into Spassked. Mr Wright also understood, during the 1991 Year, that Spassked had carry forward tax losses and that, if dividends were paid into Spassked, the amount of the carry forward losses would be reduced by the quantum of the dividend paid into it. He understood that the effect of paying dividends into Spassked would be to consume tax losses. However, he did not accept that that was an additional reason for not paying dividends into Spassked.

159. Mr Wright understood that, under the constitution of GIH, franked dividends could be paid to one entity and unfranked dividends to another. He believed that that result flowed from the rights that were attached to the shares in GIH held by IEL and Spassked. However, Mr Wright had no knowledge of the precise language of the constitution of GIH.

160. Mr Wright understood that the IEL officers who had been involved in implementing and maintaining the Spassked Structure had been directed, either by the board of IEL or by senior management, to determine, together with external advisers, how to solve the problem. Mr Wright, as a director of IEL, was kept informed in relation to the progress made, but was not involved in considering the issue in any detail. While he was not involved in resolving the problem in any technical way, he was aware that a lot of work was done by those officers in seeking to resolve the problem. In particular, Mr Wright remembers seeing a memorandum, which may have been the September 1990 Memorandum. Mr Wright accepted that the second paragraph of the September 1990 Memorandum refers to an objective that is a tax outcome. Mr Wright was unable to locate any other document that was produced pursuant to the direction given to IEL.

161. Mr Wright understood that Spassked continued to incur interest for a period of time. He understood that the circumstance in which Spassked would cease to incur interest would be the repayment of loans and then the making to Spassked of interest free loans. He was aware of the steps by which Spassked ceased to incur interest to IEF, but was not involved in the detail. In his capacity as a director of Spassked, Mr Wright approved whatever occurred. However, he had no recollection of who specifically implemented any steps taken by Spassked.

162. Mr Wright understood that, by early 1991, IEL had moved from a substantial forecast profit position to a forecast loss position, largely as a result of asset write downs, although the underlying businesses were still running profitably. He understood that, while there was, therefore, no longer any urgency, by 30 June 1991, to resolve the Spassked problem, he expected that work would continue to be done on resolving the issue by the management of IEL and their internal tax experts. He believed Messrs Cottam, Daniels and Eggert were the officers involved.

163. In the course of preparing the BT Plan, Mr Ryan had become aware of the Spassked dividend trap. Mr Ryan did not know what assets in the IEL Group were held by GIH and its subsidiaries and the dividend trap question did not affect his view as to the planned asset sales. He understood that other IEL officers were investigating ways to resolve the dividend trap question and had been doing so for some time. By mid 1992, he understood that a plan had been devised whereby Spassked's debt to IEF would be repaid.

Disputes with the Commissioner

164. On 21 March 1991, heads of agreement ( the Heads of Agreement ) were signed on behalf of the Commissioner, the Ultimate Parent Companies, National Consolidated Limited and Petersville Sleigh Limited. The Heads of Agreement recorded a settlement reached between the Adsteam Group and the Commissioner in relation to taxation matters arising in connection with the income year ended 30 June 1990 and prior years. The Heads of Agreement were amended by a further instrument dated 15 May 1991.

165. One effect of the Heads of Agreement, as amended, was that $300 million of losses would be available to the Adsteam Group to be carried forward, provided that the Commissioner could be satisfied as to the validity of the losses incurred by specific companies. Clause 8.1 was in the following terms:

"Carry forward of losses of up to $300 million as at 30 June, 1990… are to be allowed to be carried forward by nominated companies in the Adsteam Group, the David Jones Group, Tooths Group and the IEL Group provided that such companies have satisfied the Commissioner that after the transfer of losses under s 80G of the Tax Act and upon inquiry into the transactions entered into by the loss companies concerned, the losses nominated for carry forward purposes exist to the extent claimed."

166. Deloitte Ross Tohmatsu ( Deloittes ), who were advising the Adsteam Group, informed the Commissioner that the Adsteam Group wished to allocate to Spassked the bulk of the $300 million losses to be carried forward. A submission was made to the Commissioner on that basis by Deloittes to Ferrier Hodgson, who were then advising the Commissioner.

167. By letter of 16 December 1991 ( the Walmsley Letter ), the Commissioner observed that, until receipt of a letter of 10 April 1991, when Spassked was nominated as the repository of carry forward losses in excess of $300 million, the only information provided to the Commissioner in relation to Spassked was its tax return for the year ended 30 June 1987, showing assets of $2 and no activity. The Walmsley Letter asserted that the affairs of the IEL Group and its corporate structure were very complicated and that very little information had been provided to the Commissioner about Spassked. The letter said that those considerations had their effect on the Commissioner's ability to be satisfied in terms of clause 8.1 of the Heads of Agreement. The letter said that, on the present state of the evidence available to him, the Commissioner could not be satisfied that Spassked or the IEL Group had available, as at 30 June 1990, $300 million, or any amount, of losses to be carried forward.

168. The Walmsley Letter referred to an assertion in a letter from the IEL Group that the interest paid by Spassked was an allowable deduction under s 51 of the Assessment Act, because dividends had been received by Spassked from GIH and further dividends were expected to be received in the future. The Walmsley Letter said that there was no evidence before the Commissioner that dividends approaching the amount of interest being incurred would be derived. The letter asserted that the IEL Group had not provided any material that would show that any dividends at all would be paid in the foreseeable future. The Walmsley Letter also said that, where there is a large disparity between outgoings and income, it is not self evident that the outgoings ought to be characterised as incurred in gaining or producing assessable income or in carrying on business for such purpose. It asserted that, in such a case, it is necessary to examine the whole of the transaction of which the outgoings form part, in order to characterise those outgoings.

169. On 2 June 1992, Deloittes replied to the Walmsley Letter, confirming the losses to be carried forward as at 30 June 1990 that made up the $300 million referred to in the Heads of Agreement. Of the $300 million, $80 million was attributed to Spassked. Deloittes requested the Commissioner's agreement to the figures. By letter of 5 June 1992, the Commissioner agreed that, for the purposes of clause 8.1 of the Heads of Agreement, the losses to be carried forward as at 30 June 1990 were as set out in the letter of 2 June 1992.

170. Mr Wright understood that, under the Heads of Agreement, the Commissioner was to allow the Adsteam Group to carry forward $300 million in allowable losses, with the allocation of those losses within the companies of the Adsteam Group to be negotiated later. He understood that, throughout 1991, IEL negotiated with the Commissioner for such an allocation, but that, in December 1991, the Commissioner had rejected the proposal to allocate the bulk of the $300 million losses to Spassked. Mr Wright was aware of the receipt of the Walmsley Letter at that time. Mr Wright was also aware of the letter of 2 June 1992 from Deloittes to the Commissioner and the letter in response of 5 June 1992, pursuant to which the Commissioner agreed that, for the purposes of clause 8.1 of the Heads of Agreement, the losses to be carried forward by Spassked as at 30 June 1990 would be $80 million.

171. Following receipt of the Walmsley Letter, Mr Wright had the carriage of negotiations with the Commissioner on behalf of IEL. He attended a large number of meetings with representatives of the Commissioner to discuss the issues raised. Mr Wright reported regularly to the directors of IEL on the progress of the negotiations with the Commissioner. He wanted to settle the dispute with the Commissioner as soon as possible, so that the proposed debt rationalisation and asset sale process could be finalised. It was his intention, once an amount had been agreed and paid to the Commissioner in settlement of any tax liability, that the funds retained by the relevant companies after the realisation of any external debt would be used to close the Spassked dividend trap and to facilitate the payment of dividends to IEL and then to Dextran. While Mr Wright asserted that, on many occasions during the course of his discussions with the Commissioner and the Commissioner's officers, he communicated to the Commissioner the intention to pay dividends from GIH to Spassked, he was unable to produce a document that recorded or evidenced any such communication prior to 27 April 1995. On the other hand, the Commissioner adduced no evidence to negate the assertion.

172. On 9 February 1995, Mr Wright, Mr Cottam and Mr Michael Wiley of Mallesons met with officers of the Commissioner to discuss the loss incurred by Spassked in the 1992 Year. The Commissioner's officers indicated a concern that there was a large discrepancy between the interest expense, of approximately $3 billion, incurred by Spassked between 1988 and 1993 and the dividend income received, of approximately $43 million. Because of the large discrepancy, the Commissioner was concerned that there may have been some other purpose for Spassked incurring the interest expense. The Commissioner's officers were informed that, while there was a large discrepancy between the amount of interest incurred and the income derived, it had to be appreciated that there was approximately $3.1 billion of value in excess of Spassked's investment in GIH and in due course Spassked would receive, by way of dividend, an amount substantially equal to its expense over the relevant period. The Commissioner's officers requested further information in relation to the retained earnings of the subsidiaries and the IEL representatives agreed to provide copies of the financial statements, as at 30 June 1994, of those companies that invested directly or indirectly in Woolworths. It was agreed that there would be a further meeting on 2 March 1995 to discuss the Commissioner's view in relation to Spassked, following the receipt of that information.

173. On 17 February 1995, Mr Cottam sent to the Commissioner a diagram setting out Spassked's shareholding in the companies that directly or indirectly held shares in Woolworths as at 30 June 1994, together with a schedule setting out the retained earnings, as at 30 June 1994, of the subsidiaries of GIH that directly or indirectly had invested in Woolworths. Also enclosed were financial statements as at 30 June 1994 for Spassked and the subsidiaries that directly or indirectly invested in Woolworths. Mr Cottam did not identify a number of other subsidiaries of Spassked that had retained earnings and losses, because of the substantial amount of time that it would take to tabulate that information. Mr Cottam said in his letter that a preliminary examination revealed that dividends in the order of $3.1 billion could be paid to Spassked.

174. On 2 March 1995, Messrs Wright, Cottam and Wiley met with officers of the Commissioner again to discuss the loss incurred by Spassked for the 1992 Year, part of which had been transferred to Woolworths in the 1992 Year. The Commissioner's officers acknowledged receipt of the letter of 17 February 1995 and indicated that the Commissioner could now see the argument that there was a substantial amount of retained earnings located below Spassked, which could enable a substantial dividend to be received in due course. However, the officers said that they had difficulty with the fact that it had now been some six or seven years since Spassked had begun incurring interest expenses and they wanted to know when it was expected that a dividend would be paid. A letter dated 2 March 1995 was provided to the IEL representatives at the meeting.

175. In the 2 March 1995 letter, the Commissioner referred to the meeting on 9 February 1995 and the letter of 17 February 1995. In particular, the Commissioner's letter referred to the statement in the letter of 17 February 1995 that dividends in the order of $3.1 billion could be paid to Spassked. The Commissioner said that it was understood, from the discussions at the meeting on 9 February 1995, that change in commercial and economic circumstances may dictate that alternative courses of action may be pursued. The letter asked whether, notwithstanding the possibility of such change, it was the primary intention of the IEL economic entity to "stream funds (ie retained profits) upward through the group structure via Spassked". The Commissioner's letter asked when it was envisaged that a dividend in the order of $3.1 billion would be paid to Spassked.

176. On 27 April 1995, Mr Cottam wrote to the Commissioner in response to the letter of 2 March 1995. At that time, Spassked was no longer a dividend trap. In response to the enquiry as to when a dividend would be paid to Spassked, Mr Cottam said that it was his understanding that it was intended that, when practicable, each IEL subsidiary would declare dividends to its shareholders. That would result in substantial dividend flows to Spassked. Mr Cottam said that it was not known when dividends in the order of $3.1 billion would be paid to Spassked as, amongst other matters, the final quantum of the dividends was dependent upon the determination of the deductibility of Spassked's interest payments to IEF and, hence, availability of losses transferred by Spassked to other companies in the IEL Group and the tax liabilities, if any, of those companies. Mr Cottam's letter said that, only after the tax liabilities, if any, had been ascertained, could the profits available for distribution be determined and the dividend paid.

Asset sales by the IEL Group

177. The major assets of the IEL Group were progressively sold or realised between 1994 and 2002. In particular:

178. In early 1993, after the decision had been taken to proceed with the sale of Woolworths, Mr Wright sought advice from Mallesons as to whether a dividend could be paid. By letter of 8 March 1993, Mallesons advised that there were considerable personal risks for directors in permitting a company to pay a dividend in circumstances where there was a reasonable concern that additional tax may become payable and the payment of the dividend reduced the ability of the company to satisfy the tax liability. The advice was that that risk existed even if the directors presently believed that it was more likely than not that tax would not finally be payable. A decision was therefore made not to declare dividends until the tax liability could finally be determined. However, Mr Wright was unable to explain the dividends that were in fact declared after that decision was made.

179. Mr Libbesson understood, by early 1992, that the IEL Group were considering liquidating a number of subsidiaries, as part of a process of cleaning up the IEL Group. He was asked to assist in that project. He understood that Dextran desired the sale of IEL's assets and that the proceeds be used to repay the IEL Group's external debt. The remaining funds would be distributed to Dextran. Over the next two years, Mr Libbesson assisted the IEL Group in connection with most of the sales of assets that it undertook during that period.

180. As part of the liquidation project, Mr Libbesson had discussions with IEL personnel, including Messrs Cottam and Daniels, about the Spassked Structure and the payment of dividends by GIH to Spassked. He noted in the course of those discussions that, if the assets held by subsidiary companies of GIH were sold, there would be no further use for those companies. Accordingly, once the relevant assets were sold and the subsidiaries liquidated, all of the capital and profits of those subsidiaries could be returned to GIH. GIH, in turn, could be liquidated and its capital and profits could be returned to Spassked. Spassked would then be able to repay so much of the IEL loan that remained outstanding and pay a dividend to IEL, after which it could be liquidated. IEL could use the funds received to repay external debt or to distribute funds to Dextran. However, Mr Libbesson has no recollection of giving advice as to those matters.

181. Mr Libbesson understood that a potential impediment to the liquidation project arose when the Commissioner informed the IEL Group, by the Walmsley Letter, that he was not satisfied that the Spassked losses claimed by IEL Group companies were allowable deductions. Mr Libbesson was not asked to give advice in relation to the Walmsley Letter. However, he was of the view that, if the Commissioner maintained his position in relation to the unavailability of the losses, it was unlikely that he would issue the necessary tax clearance certificates to companies that were the recipients of the transferred losses. Without such certificates, the subsidiaries could not be liquidated. In view of the possible difficulties in obtaining such certificates, other methods of distributing funds held by subsidiaries of GIH were considered. One proposal discussed was to convert the relevant subsidiaries to unlimited liability status. That would enable those subsidiaries to return their capital to shareholders without having to obtain an order of the Court. As that procedure did not involve liquidation, it would not be necessary to obtain a tax clearance certificate. That method of distributing funds was in fact implemented in relation to some companies within the IEL Group in the 1994 Year.

182. Mr Libbesson discussed with Messrs Daniels and Cottam different methods of reducing Spassked's outstanding debt to IEF. They decided the best way would be for those GIH subsidiaries that had funds on deposit with IEF to recall those deposits and lend the funds on interest free terms to their immediate parent companies. The funds would then be lent on interest free terms up the shareholding chain to Spassked. Spassked would then use the funds to repay the interest bearing debt to IEF. That plan was approved by the directors of the relevant companies in June 1992.

183. From June 1992 until 30 June 1994, Mr Libbesson was involved in numerous meetings with IEL officers, including Messrs Daniels and Cottam, concerning subsidiaries that had sold their assets and then placed the proceeds of sale on deposit with IEF. However, Mr Libbesson was not asked to give advice in relation to those matters. Mr Libbesson was present at meetings where proposed dividends were discussed. However, he accepted that, as a general rule, the idea was that losses should be utilised before any dividends would be paid.

184. Between May 1992 and August 1992, Mr Ryan reviewed each asset of the IEL Group in order to determine the best time at which, and the best way in which, to sell the assets. From August 1992, he commenced preparing some of the assets for sale. While he was not involved in the due diligence enquiries conducted before the float of Woolworths, he later became involved generally in the preparations for the float. He was involved in the sale of all of the major assets of the IEL Group from 1992. While Mr Lyn Shaddock, a property consultant, conducted all of the property sales for the IEL Group until 1995, Mr Shaddock reported to the IEL Group's directors, which, from February 1993, included Mr Ryan.

185. Mr Ryan continued to make recommendations to the directors of IEL as to which assets should be sold, when those assets should be sold and at what price. He advised as to which assets the IEL Group should continue to hold and which assets required fixing or developing before sale. Following the resignation of Mr Haines as chief executive of IEL on 29 July 1993, an executive management team was established consisting of Mr Wright, Mr Shaddock and Mr Ryan. They worked together with various business managers in the IEL Group to consider asset sales and to implement the IEL business plans. Mr Ryan also continued to be involved in the sale of assets by the Ultimate Parent Companies and their respective subsidiaries.

186. Mr Ryan expected that the proceeds from the float of Woolworths would enable the IEL Group to repay its external debt in full. He understood that, after the external debt had been repaid, it would have been open to the directors of IEL to declare a dividend out of retained profits, utilising the cash sale proceeds. The sale proceeds would be located in Harbourfort Pty Limited ( Harbourfort ), the holding company of Woolworths. Harbourfort would then be required to declare dividends to its immediate holding company, which in turn would declare dividends ultimately to IEL, which could then declare a dividend to Dextran. However, having regard to the Walmsley Letter, Mr Ryan was concerned as to whether a dividend could be declared, in light of the issue raised by the Walmsley Letter as to the deductibility of Spassked's interest expense and, hence, the availability of losses transferred by Spassked to other IEL Group companies. He regarded the tax position of the IEL Group companies to be uncertain. In those circumstances, he considered that it was difficult to form a view as to the level of profits available for distribution. He was concerned that it may later be suggested that payment of a dividend in those circumstances amounted to an illegal reduction in capital.

187. Given the uncertainty created by the Walmsley Letter and having regard to the advice from Mallesons of 8 March 1993, Mr Ryan and the other directors of the IEL Group companies decided that, in general, the IEL Group should not pay dividends. The issue as to the payment of dividends was of great concern to Mr Ryan and the other directors. Nevertheless, there were several instances where dividends were paid by some IEL Group companies for specific reasons. Specifically, a dividend of $240 million was paid by Woolworths to Harbourfort prior to the release of the prospectus for the float of Woolworths, because it was necessary for the retained profits of Woolworths to be paid out to its owner prior to the float.

188. Ultimately, the proceeds of the Woolworths float were lent through the inter-company chain to GIH, which lent the funds to Spassked, which used the funds to repay part of its indebtedness to IEF. IEL and IEF then used those funds to repay the IEL Group's external debt. Surplus funds were lent by IEL, interest free, to Dextran. Over time, surplus funds from later asset sales were also advanced by IEL to Dextran in that manner.

189. Mr Ryan expected that, once the taxation position had been resolved, dividends would be declared and paid through the corporate group, including by GIH to Spassked. Mr Ryan expected that those dividends would be applied to offset the intra-group loans and the loans from IEL to Dextran. Mr Ryan accepted that the likelihood of dividends being declared to Spassked, while it was a dividend trap, was low, but said that it was not impossible. He also agreed that, while Spassked was the repository of carried forward losses, the likelihood of dividends being paid to Spassked was low, but said it was not impossible. Mr Ryan said that his expectation was that, at the first possible moment that they were able to pay dividends up the chain in any given year, they would do so. He accepted that it was unlikely that that would happen while Spassked was a dividend trap and had carried forward losses, but said that it was nevertheless possible. He said that, if it had to be done, it could and would be done, but that the more likely outcome was that the dividend trap would be closed before dividends would be declared.

190. Mr Ryan accepted that all of the tangible assets of GIH and its subsidiaries were realised and the proceeds provided to IEL to enable it to discharge its external debt and to retain an amount pending the determination of the present taxation dispute, without the payment of any dividend to Spassked. The result was that Spassked owns shares in GIH, whereas the only asset that GIH has is a debt owed to it by Spassked and the only thing left to be done is to bring everything to an end, to wind up the companies and deregister them. Mr Ryan considers that there is a myriad of ways of achieving that end. When asked whether, apart from wanting to bring things to an end, there was no other benefit in declaring dividends, Mr Ryan responded that it goes to the taxable status of the Group. He asserted that it has been the case, since the early 1990s, that the directors of Spassked and the IEL Group have all wanted to pay a dividend but have never been able to do it because of the stance taken by the Commissioner.

191. Mr Wright oversaw the preparation and implementation of the business plans and budgets for the Adsteam Group. The goal of the plans was to reduce the debt for the Adsteam Group by realising assets. In preparing the plans and implementing them, careful analysis was conducted of the businesses as to how they were managed, who was involved in managing them, what their underlying value was, and what could be done to maximise their underlying value. Each of the business plans of IEL was directed towards realising assets to enable IEL's debt to be repaid and then distribute all surplus cash to Dextran and then to the Ultimate Parent Companies.

192. For example, the business plan for IEL for the 1994 Year stated that it was intended to enable the payment in full of the IEL Group's debt, which could be achieved through realisation of its assets in an orderly manner at the maximum price achievable. The plan stated that that could be achieved by maximising the cash flow of IEL, thereby enabling IEL, once the debt of IEL had been repaid in full and adequate funds were retained to meet future liabilities, "to upstream the maximum amount of cash possible to the Group's shareholders". Mr Wright accepted that reference to the "Group's shareholders" was to Dextran. Mr Wright accepted that that objective was in fact achieved, in that moneys were "upstreamed". Specifically, he accepted that the assets of the IEL Group were realised and that the debt of IEL was repaid in full, from the proceeds of the realisation.

193. Mr Wright prepared an IEL Group finance summary as at 30 June 1994. He accepted that the contents of that document demonstrated that a large quantum of money was "upstreamed" to Dextran by 30 June 1994 by way of loan. The document recorded:

Mr Wright could not recall whether those distributions represented the surplus of the proceeds of sale of the IEL assets.

194. The IEL financial report for the 1994 Year showed that current assets constituted the vast bulk of the total assets of the IEL Group at that time and that the vast bulk of the current assets consisted of cash and receivables. The vast bulk of the receivables comprised a loan to Dextran of $1.2 billion and the vast bulk of the realisable assets of the Group had been realised. Further, as a result of the Woolworths float in 1993, IEL was able to pay off its debts and distribute over $1 billion to Dextran by way of loan. Those events occurred pursuant to the plans that had been put into effect following the BT Plan and the later business plans that were formulated pursuant to the BT Plan. The sale of the assets in the IEL Group, the discharge of the IEL Group's debt and the distribution of the surplus of the proceeds to Dextran were all achieved without payment of a dividend to Spassked.

195. The proceeds of the sale of IEL's assets were required to be applied first to repay the IEL Group debt and then to be distributed to Dextran and then to the Ultimate Parent Companies, so that they could, in turn, repay their debts to lenders. Mr Wright had envisaged that the proceeds of asset sales would have been distributed by way of dividend or liquidation to each of the immediate holding companies in the corporate chain. The business plans were prepared on that basis. However, Mr Wright considered that that was ultimately not possible because of the Commissioner's questioning the deductibility of Spassked's interest payments to IEF and the availability of the losses that Spassked has transferred to other companies in the IEL Group, including subsidiaries of GIH.

196. Mr Wright's attention was drawn to the declaration of a dividend of $361,260,000 from Woolworths to Harbourfort and the declaration of a dividend of the same amount by Harbourfort to National Super Market Pty Ltd ( NSM ) in the 1992 Year. Mr Wright's recollection was that the first dividend was in connection with the original proposal for the float of Woolworths but he could not give any explanation as to why a dividend was declared by Harbourfort to NSM.

197. Mr Wright intended that the number of entities within the IEL Group would be reduced in order to reduce administration costs. Where possible, dividends would be declared through the corporate chain. There was a desire to liquidate those companies that no longer had any assets or activities. However, Mr Wright did not regard Spassked as part of that proposal.

198. Prior to the payment of dividends or liquidation distributions, it was proposed that IEL Group subsidiaries would lend any funds on deposit with IEF to their immediate holding companies. That was regarded as being the first step to ready the IEL Group subsidiaries for liquidation and would allow the holding companies to gain access to the cash in the IEL Group sooner. Mr Wright accepted that the proposal that loans of funds on deposit with IEF would be made to immediate holding companies was not directed to the payment of dividends.

199. Mr Wright understood or believed, at the time the liquidation project was conceived, that, once the subsidiaries of GIH had sold their assets, including Woolworths, those subsidiaries would be liquidated and would distribute their profits to GIH by way of liquidation distribution or by dividend prior to liquidation. GIH itself would then be liquidated and would pay a dividend or liquidation distribution to Spassked. In the meantime, GIH subsidiaries could distribute cash by way of interest free loans to shareholders. Mr Wright understood that that would allow Spassked to repay its debt to IEF and thereby close the dividend trap.

200. Some time after the liquidation project began, Mr Wright was informed by IEL executives that the liquidation project had struck a problem, because in many cases the tax clearance certificates that were required to be obtained from the Commissioner prior to liquidation were not forthcoming. If such clearance certificates could not be obtained, the companies could not be liquidated. He understood that, as a result, the liquidation project was not able to proceed to the extent planned the project was still on foot at the time that Mr Wright resigned as a director of IEL in November 1995.

The earlier proceeding

201. The question of whether interest paid in the 1992 Year was an allowable deduction was determined against Spassked in the Earlier Proceeding, when the Court found that the interest incurred in the 1992 Year was not deductible under s 51(1), because the occasion of the incurrence of the interest lay in the deliberate non-production of assessable income (see the Earlier Proceeding at [185], [243] and the First Full Court at [110], [111], [113] and [125]). I have already made some findings above on the basis of the Earlier Proceeding. It is desirable to say something further about the findings made in the Earlier Proceeding in the light of the Commissioner's contentions that the Taxpayers' case involves an abuse of process, because of the findings made in the Earlier Proceeding.

202. Relevantly, the following findings were made in the Earlier Proceeding:

203. In the Earlier Proceeding, both parties put their cases on the premise that the relevant time or period in which to determine the expectation or purpose of Spassked, in its role as a dividend trap and repository of transferable losses, was the period over which the funds were borrowed from IEF, namely from 30 December 1987 to 28 June 1990, and that there was no relevant change of circumstances, including a change in the motivation or the subjective purpose of the directors of Spassked, throughout that period (Second Full Court at [21]). The First Full Court accepted that it was common ground between the parties that there were no relevant factual changes "in any relevant year of income". The Second Full Court considered that the First Full Court, in so saying, was referring to the fact that there was no relevant factual change throughout the three years of income in which the borrowings were made and the borrowed amounts were invested in GIH, being the years of income ending 30 June 1988, 1989 and 1990. The Second Full Court concluded that the case that the Taxpayers wished to conduct in the Current Proceedings is not the case that was conducted by Spassked in the Earlier Proceeding (Second Full Court at [26]).

204. The First Full Court observed that the question whether interest was incurred in gaining or producing assessable income or in carrying on a business, the purpose of which was the gaining of assessable income, is required to be determined from year to year. The First Full Court said that the Earlier Proceeding had been argued and determined on the basis that the relevant facts were those that existed at the time the Spassked Structure was implemented. It seems to have been common ground in the Earlier Proceeding that there was no relevant factual change in any relevant year of income. While the First Full Court was content to adopt the same course, it noted that, had there been a relevant factual change, such that Spassked would no longer be precluded from deriving assessable income indefinitely, the outcome would then be different (the First Full Court at [77]).

205. Ordinarily, where a taxpayer borrows money for the purpose of acquiring shares that carry rights to a dividend, the interest on the funds borrowed will be deductible, without reference to subjective matters. On the other hand, however, where no dividends are derived by a taxpayer from an investment in shares and no dividend was intended to be paid on the shares for an indefinite time, the result will be different. In such a case, the occasion of incurring the interest in the year of income would not be found in gaining or producing assessable income at all. In the Earlier Proceeding, the question whether dividends were to be paid on the shares in GIH acquired by Spassked with the funds borrowed from IEF was the subject of considerable evidence and a conclusion was drawn adverse to Spassked (the First Full Court at [76]).

206. Before the Second Full Court, the Taxpayers contended that there were several points of distinction between the issues raised in the Current Proceedings, so far as deductibility of interest payments by Spassked in the 1991, 1993 and 1994 Years is concerned, and the issues in the Earlier Proceeding, so far as the deductibility of interest payments made by Spassked in the 1992 Year is concerned. The Second Full Court accepted that those contentions are at least arguable, to the extent that the Current Proceedings should go to trial rather than be dismissed summarily.

207. The Taxpayers maintain that, in the Earlier Proceeding, Spassked argued that the deductibility of interest in the 1992 Year was to be determined by reference to the circumstances that existed when the loans were made. They say that, in the Earlier Proceeding, it was held that the character of the interest expense must be determined as at the time of its incurrence, being the times of the borrowings from IEF on which the interest accrued and that it was at those times that expectations and purposes were to be identified (the Earlier Proceeding at [242]). Accordingly, they say, the findings made in the Earlier Proceeding concerning purpose, intention or expectations do not extend beyond that time, namely 30 December 1987 to 28 June 1990.

208. The Taxpayers now contend that, when interest expenses to IEF were incurred by Spassked in the 1991, 1993 and 1994 Years, it was the intention and expectation of the directors of Spassked, in those years, that dividends would be paid by GIH to Spassked at the earliest available opportunity and that there was the potential for such dividends to be paid. They say that, from the time the BT Plan was adopted, it was inevitable that Spassked would eventually receive from GIH, either a distribution of unfranked dividends or an assessable liquidation distribution, approximately equal to or greater than the interest expenses it claimed as deductions. There would be no other way, they say, for the subsidiaries of GIH to be wound up and the underlying profits distributed.

209. Thus, the Taxpayers contend that, whatever might have previously been the position up to 28 June 1990, there was no longer any expectation on the part of Spassked or IEL in the 1991, 1993 and 1994 Years, that the Spassked Structure as a dividend trap would remain in place indefinitely. Rather, in the 1991, 1993 and 1994 Years, they say, Spassked had an expectation that the incurring of that interest expense would ultimately produce assessable income in the form of dividends from GIH, representing a return on its investment of the borrowings that generated the liability for interest. They say that that conclusion is not precluded by the determination made in the Earlier Proceeding in relation to the 1992 Year.

The deductibility of the interest payments

210. The Taxpayers made different submissions in relation to the 1991 Year, on the one hand, and the 1993 and 1994 Years, on the other, although there is a considerable overlap. The significant differentiating factor between the two is the intervening 1992 Year, in respect of which findings were made in the Earlier Proceeding.

211. By the end of June 1990, most of the IEL Group's operating subsidiaries were subsidiaries of GIH, which was itself a subsidiary of Spassked, by reason of its holding of A Class shares. Substantial profits in the subsidiaries of GIH were unfranked and therefore could not be distributed to IEL in respect of the B Class shares. Unfranked dividends could only be distributed through Spassked in respect of its A Class shares.

212. The Taxpayers say that the relevant intention and expectation of Spassked during the 1991 Year was evidenced by the following:

213. The Taxpayers say that, even if GIH would not have paid, or was unlikely to have paid, dividends to Spassked until Spassked had transferred out all of its accumulated losses to other members of the IEL Group, which did not occur until 30 June 1997, a deduction would nevertheless be allowable under the first limb of s 51(1) if there were an expectation and intention that dividends would be paid, and there was the potential for dividends to be paid, albeit in the long term. They say that there was a change from the earlier expectation, that the Spassked Structure as a dividend trap would remain in place indefinitely, such that the relevant connection between the interest expenses and the expectation of income, in the form of dividends in the future, was then present, with the consequence that the interest expenses in the 1991, 1993 and 1994 Years are deductible. They say that the borrowed funds on which the interest was payable were, in the 1991 Year, being used for an income producing purpose, namely, the derivation, in the future, of dividends on the shares acquired with the borrowed funds. The mere deferral of income for a period of seven years from 1990 to 1997 did not, of itself, render the interest payments non-deductible. An arrangement that will generate substantial tax losses for some years will not necessarily prevent from being deductible, an interest expense incurred from the beginning.

214. The circumstances applicable to the 1991 Year were also applicable, the Taxpayers say, to the 1993 and 1994 Years. Further, after the end of the 1992 Year, steps were being taken to eliminate the Spassked dividend trap. Further, the BT Plan was being put into effect and the liquidation of the IEL Group was proceeding.

215. Most of the significant assets of the IEL Group had been sold by 30 June 1994, when there was a consolidated fund of profits in GIH and its subsidiaries of more than $3 billion. In excess of 95% of those profits were unfranked. The Taxpayers say that those profits were only capable of being distributed to Spassked, because they were unfranked. They say, however, that the proceeds of asset sales and accumulated profits in the IEL Group could not be distributed by way of dividend because, by the Walmsley Letter, the Commissioner had questioned the deductibility of Spassked's interest expenses. Because Spassked had transferred the losses arising from the interest expenses to other members of the IEL Group, the prospect arose that the other members of the IEL Group might be subjected to amended assessments and have insufficient profits available to distribute. In that context, the IEL Group directors received the legal advice that they could not and should not pay dividends within the IEL Group until the tax position had been resolved. Therefore, from the time of receipt of the Walmsley Letter, dividends were for the most part not paid within the IEL Group, and no dividends were paid to GIH after 1991.

216. However, there were occasional instances where, for specific reasons, dividends were paid after the receipt of the Walmsley Letter. For example, a dividend was paid by Woolworths prior to the float of Woolworths. In that case, funds had been put aside to ensure that, to the extent that Woolworths had received Spassked losses that were not ultimately allowed, the liability could be met.

217. Instead of paying dividends, available funds were paid to the Adsteam Group by way of intercompany loan. It was the intention and expectation, the Taxpayers say, that, once the dispute with the Commissioner had been resolved, dividends would be declared within the IEL Group, which would be offset against those loans. By April 1995, IEL had indicated to the Commissioner that it was in a position to pay a dividend in the order of $3.1 billion to Spassked, subject to the Commissioner's determination to allow the deductibility of Spassked's interest expenses.

218. The Spassked dividend trap was eliminated as at 30 June 1994 and the last of the Spassked losses were transferred, at the latest, in the 1997 Year. Ultimately, therefore, the Taxpayers contend, there will be no disproportion between the interest expenses incurred by Spassked on its borrowings from IEF and the dividends to be paid to Spassked by GIH. The total profits earned by GIH's subsidiaries, acquired with funds subscribed by Spassked, which Spassked had borrowed from IEF, in fact approximated the cost to Spassked of making its investment in those subsidiaries, through its shareholding in GIH. The Taxpayers assert that the denial of deductibility of the interest payments, but the continued inclusion of those payments as assessable income of IEF, has created an economic distortion of significant proportions.

219. While there may have been a desire on the part of the Ultimate Parent Companies for dividends for the reasons outlined, that desire was for immediate distribution of dividends. The purpose of the distribution to Dextran, and then to Dextran's shareholders, was to enable the Ultimate Parent Companies to receive distributions in the form of dividends as soon as possible. The desire to receive such distributions would be totally frustrated if they were not to be made for upwards of seven years. Yet, that was what happened. That is to say, notwithstanding that it is said that the intention and expectation of the Ultimate Parent Companies was that the distributions be made at the earliest available opportunity, the distributions have not yet been made. The Taxpayers point to the outstanding tax dispute with the Commissioner, as to the deductibility of transferred losses, to explain that failure to make distributions.

The first limb of s 51(1)

220. It was intended, from the outset, that Spassked would be a dedicated dividend trap and that Spassked would not have any income from which interest could be paid. Hence, it was necessary that the interest be capitalised. Making Spassked a dividend trap enabled other companies within the IEL Group to cease to be, or to cease to have the potential of being, dividend traps. The Commissioner contends that the incurrence of interest by Spassked and the non production of assessable income by Spassked are both matters that the IEL Group deliberately chose from the outset and the evidence is that they were the consequences that the IEL Group perpetuated for the entirety of the implementation of the Spassked Structure through to the end of the 1994 Year.

221. Thus, the Commissioner says, the receipt of dividend income by Spassked from GIH was never a feature of the Spassked Structure because:

222. Several differences are advanced on behalf of the Taxpayers as to why the position in relation to the 1991 Year, the 1993 Year and the 1994 Year is different from the position up to 30 June 1990, that being the basis upon which the Earlier Proceeding was conducted and findings were made, in relation to the 1992 Year. The Taxpayers contend that, as a consequence of those differences, there was a relevant nexus between the interest expenses incurred in the 1991, 1993 and 1994 Years with the gaining or producing of assessable income, even if there was not such a nexus with the interest expense incurred in the 1992 Year. I do not consider that the differences lead to a different conclusion in relation to the 1991, 1993 and 1994 Years.

223. There are several answers to the proposition that there was a change of intention or purpose, dating from the takeover of IEL by Dextran, which was effective from November 1989, by reason of the desire for the distribution of all profits of the IEL Group, by way of dividend to Dextran. First, the assertion by the Taxpayers that, inevitably and necessarily, of the dividends that Dextran wanted to extract from IEL, the unfranked portion had to be paid by GIH to Spassked, was a purely theoretical proposition. In fact, on the Taxpayers' own evidence, the reality was that, during the 1991 Year, the 1993 Year, and the 1994 Year, GIH continued the same deliberate withholding of dividends from Spassked, which had been a central tenet of Spassked's existence from the beginning.

224. Further, there were ways of getting unfranked dividends from GIH to IEL without passing them through Spassked. IEL, as the only shareholder of Spassked, could have directed Spassked to vote in favour of the alteration of the articles of GIH to permit unfranked dividends to be distributed direct to IEL. For example, redeemable preference shares could be issued to IEL and a dividend declared on those shares. Alternatively, the rights attaching to the B Class shares could have been altered to permit unfranked dividends to be declared on those shares. The arrangements were inherently variable and, accordingly, it is not necessarily correct to say that Dextran's desire that dividends should come out of IEL created an objective purpose or expectation that dividends had to flow from GIH to Spassked.

225. The consideration given in late 1990 to the elimination of the Spassked dividend trap is also said to constitute a difference. The only contemporaneous evidence of consideration being given to the elimination of the Spassked dividend trap is the September 1990 Memorandum. However, the September 1990 Memorandum is, on its face, concerned with tax issues. That is to say, it is directed to ensuring ongoing tax deductibility of the interest expenses being incurred by Spassked. In any event, the consideration given to the elimination of the Spassked dividend trap was fleeting and the possibility of eliminating the Spassked dividend trap was not pursued. It does not appear to have begun before mid 1990 or to have lasted any later than January 1991.

226. By the time Mr Eggert left in December 1992, there had been no resolution of the question and no decision had been made to eliminate the Spassked dividend trap. Spassked received no dividends during the 1991 year, the 1993 or the 1994 year. That tends to refute the Taxpayers' contention that the desire of Dextran was to extract dividends from IEL and that the consideration given to eliminating the Spassked dividend trap entailed a change in the non-income earning purpose that was found in the Earlier Proceeding to have governed Spassked's borrowings from IEF from inception. The fact that, in late 1990, the decision makers considered it necessary to terminate Spassked's incurrence of interest before it should receive dividends is an indication that the original plan and expectation, that Spassked should have no income while it incurred interest, remained in force. That suggests that the interest expense continued to lack the purpose necessary to bring it within s 51(1).

227. The essence of the finding in the Earlier Proceeding was that Spassked's investment of the borrowings from IEF was deliberately non-income earning and that that situation was intended to continue indefinitely. The Taxpayers suggest that there was a subsequent change of purpose and expectation, such that there was an expectation that Spassked would receive income in the future, although such income would be deferred, deliberately, until the income expense ceased to accrue and Spassked's debt to IEF was repaid.

228. However, the events of purported change appear to amount to no more than a determination to carry through the non-income earning character of Spassked's role for the life of its borrowings from IEF and for so long as Spassked had losses that were capable of transfer to the other members of the IEL Group. That is hardly a change of circumstance within the principles of The Kidston Gold Mines Limited Case. It is not possible to find any positive manifestation of any change, on the part of those responsible for the decision making of Spassked, in their intention and expectation as to the receipt of distributions from GIH.

229. The Taxpayers also say that the decision in December 1991 to liquidate the IEL Group changed the character of Spassked's borrowings. They say that, once it had been determined that the assets of the IEL Group, including those of GIH and its subsidiaries, would be realised, and that the IEL Group would effectively be liquidated, it was inevitable that the proceeds of realisation would eventually be distributed to Dextran by way of dividend, or by liquidation distribution.

230. There are several answers to that proposition. Even if it were inevitable that, as part of the liquidation process, a dividend, or distribution of surplus, from GIH to Spassked would occur, receipt of a dividend or an assessable distribution of surplus, as part of the liquidation process, would not be the occasion of the occurrence of the interest on the loans in the 1993 Year or the 1994 Year. The interest incurred on the borrowings in all of the years from 1988 to 1994 arose as part of the implementation of the Spassked Structure, which had as its central object and characteristic the non-derivation of income by Spassked.

231. That is to say, the Spassked Structure was established and implemented to achieve the result that the company that incurred the interest liability on intra-group loans would not derive any income. Throughout the 1991, 1993 and 1994 Years, Spassked incurred interest and continued, deliberately, not to derive dividend income. Thus, the occasion of the incurrence of the interest payable to IEF continued to be the locating of the deduction in respect of the interest in a non-income earning company, which would continue to be in a position to transfer the resulting losses to other members of the IEL Group.

232. The decision to liquidate the IEL Group was not accompanied by any weakening of the resolve that dividends not be paid to Spassked, so long as it continued to incur the interest expenses and continued to have losses that it could transfer to other members of the IEL Group. Indeed, consideration in the last half of 1990, of the question of whether the Spassked dividend trap could be eliminated only affirmed that resolve. Spassked continued to incur the interest expense and continued to be a dividend trap, after the liquidation was decided upon in late 1991, through to 30 June 1994, when the borrowings were repaid and it ceased to be a dividend trap. Spassked continued to have losses that it was able to transfer to other members of the IEL Group until 1 July 1997. In the years after 30 June 1994, the situation where no dividends were paid to Spassked continued in place as it had from when the Spassked Structure was originally implemented and the borrowings by Spassked from IEF were put in place.

233. The characterisation of the decision to liquidate the IEL Group as creating a break in continuity of the original circumstances and purposes, which were the occasion of Spassked incurring interest liabilities to IEF, is not open. Expenses may fall within s 51(1), even though the assessable income, in the gaining or producing of which the expenses are incurred, may not be received in the particular year in which the expenses are incurred, or indeed at all. However, an interest expense will not be incurred in gaining or producing assessable income where the incurrence of the expense is made the very criterion by which those in control of the relevant taxpayer's receipts ensure that no assessable income will be derived. The decision to liquidate the IEL Group did not disturb the essential circumstances that dictated non-deductibility of Spassked's interest expense. Pending the liquidation, Spassked's non receipt of income was perpetuated for so long as it continued to incur interest expenses, and losses, that it could transfer to other members of the IEL Group.

234. There never was an agreed plan, mechanism or time frame according to which Spassked would begin to receive dividends. The repayment to IEF of the borrowings was not something to which anything other than a fleeting consideration was given. Rather, the inference should be drawn that it was hoped and expected that the Spassked Structure would continue as long as it was useful. The Spassked Structure, which depended upon Spassked not receiving assessable income while incurring capitalised interest, was intended to continue into the indefinite future, or until it became necessary to terminate it. Hence, for the indefinite future, while the Spassked Structure remained in place assessable income in the form of dividends was not to be received by Spassked, other than of an amount that would be relatively nominal. That is because the receipt of dividends would defeat the very structure that permitted Spassked to obtain an allowable deduction and thus transfer the losses that it would accumulate for the benefit of other companies in the IEL Group (the First Full Court at [104]).

235. The contentions about uncertainty with respect to tax liability and unwillingness to pay dividends until the question of a tax liability had been resolved are answered in several ways. After direct consideration of the matter in late 1990, those responsible continued to be unwilling to cause GIH to pay dividends to Spassked, so long as Spassked continued to be a dividend trap. Spassked continued to incur interest expenses until 28 June 1994 and had losses available to transfer to other members of the IEL Group up until 1 July 1997.

236. Irrespective of the tax dispute with the Commissioner, which may have affected decisions about the declaration of dividends generally, non-payment of dividends to Spassked had been decided upon prior to the tax dispute arising. Even after the tax dispute had arisen, dividends were paid as and when it suited the IEL Group to do so. Thus, there were four dividends as follows:

237. Further, IEL had undertaken to meet the debts of subsidiaries that might impact upon the liabilities of directors. Accordingly, the existence of the tax dispute with the Commissioner is not a satisfactory explanation for the failure to make distributions to Spassked.

238. In all of the circumstances, I do not consider that there was ever any intention or expectation on the part of Spassked, during the 1991, 1993 or 1994 Years that Spassked would derive assessable income by reason of its borrowings from IEF. The interest expenses incurred during those years were not allowable deductions.

The second limb of s 51(1)

239. The Taxpayers also contend that the interest expenses are deductible under the second limb of s 51(1). They say that, in each of the 1991, 1993 and 1994 Years, Spassked was carrying on business as a holding company within the IEL Group, holding shares in GIH. The mere holding of shares in subsidiary companies for the purpose of receipt of dividends from the subsidiary companies is sufficient to constitute the carrying on of a business. The Taxpayers say that Spassked carried on its business for the purpose of producing assessable income, being dividends that would flow from its investment in GIH and the investments that were made by GIH in its subsidiaries. The major operating businesses of the IEL Group were held within GIH and its subsidiaries and produced a consolidated fund of profits that was substantially unfranked and would therefore have to be distributed by way of unfranked dividends to Spassked.

240. However, the evidence does not support that characterisation of Spassked's position, from the time when the decision had been taken in late 1991 to liquidate the IEL Group, as one of carrying on the business of an intermediate holding company. Even if the matter were open, after it was decided to liquidate the IEL Group, Spassked continued not carrying on any business, as had been the case from its inception. Having been set up from December 1987 to suffer losses passively and to transfer them to other members of the IEL Group, the decision in December 1991 to liquidate the IEL Group did not transform Spassked's activities into the business of a holding company. It still remained passive, with those controlling its affairs still deliberately withholding dividend income from it, while interest continued to be incurred to IEF

Abuse of process

241. The Commissioner contends that the basis upon which the Taxpayers seek to draw a distinction between the conclusions reached in the Earlier Proceeding and the conclusions that the Court is invited to reach in the Current Proceedings involves an abuse of process. As indicated above, the Commissioner sought to have the Current Proceedings dismissed summarily, on the ground that the Taxpayers were estopped, by the result of the Earlier Proceeding, from advancing their contentions in the Current Proceedings. Alternatively, the Commissioner says that, notwithstanding the conclusion reached by the Second Full Court, it is an abuse for the Taxpayers to assert a change of the purpose, expectation or intention with which the interest expense was incurred by Spassked after November 1989.

242. In the Earlier Proceeding, it was concluded that the purpose of the borrowings from IEF, and hence the purpose with which the interest thereon was incurred, throughout the period in which Spassked borrowed funds from IEF, from 30 December 1987 to 28 June 1990, was not the purpose of gaining or producing assessable income. A central issue in the Earlier Proceeding was whether Spassked's borrowings during that period had been for the purpose of, or in the expectation of, Spassked deriving assessable income. That question was determined objectively, taking into account, for such evidentiary value as it had, the subjective intentions of the decision makers. That issue was resolved against Spassked.

243. The Earlier Proceeding was decided on the basis that the character of the interest expense in the 1992 Year must be determined as at the time of its incurrence, namely, at the times of the borrowings on which it accrued, from 30 December 1987 to 28 June 1990. The expectations and purposes of the relevant parties were to be identified as at those times.

244. In the Earlier Proceeding, Spassked asserted, in respect of the whole of the period from 30 December 1987 to 28 June 1990, that there was a purpose and expectation of deriving assessable income. Spassked did not seek to distinguish any sub-period within that period, or to suggest that, at any stage up to 28 June 1990, its purposes in borrowing from IEF had changed. That was so, notwithstanding that Spassked adduced evidence of the takeover of IEL by Dextran. Spassked relied on the takeover and its aftermath as an explanation as to why significant dividends were not paid by GIH to Spassked. Part of Spassked's case in the Earlier Proceeding was that the financial difficulties of the Adsteam Group thwarted plans for Spassked to receive dividends. The existence of any such plans was dismissed in the Earlier Proceeding, in which it was found that the non-payment, in fact, of dividends to Spassked was consistent with, and pursuant to, clear intentions held when the borrowings were made that there would be no distributions to Spassked.

245. More than $400 million was borrowed by Spassked from IEF in three tranches after the Dextran takeover, namely on 15 March 1990, 19 March 1990 and 28 June 1990. Interest was charged on those borrowings, thereby exacerbating the dividend trap. The Commissioner contends that a finding in the terms now sought by the Taxpayers would contradict the conclusion reached in the Earlier Proceeding that no income earning purpose was attached to the interest incurred on the amounts borrowed on those occasions. The contrary finding, that there was no such expectation at least up to 28 June 1990, was central to the conclusion in the Earlier Proceeding. The Commissioner says that a finding, as the Taxpayers now seek, that Spassked expected and intended, from November 1989, to derive dividend income, would infringe the principle of finality of judicial determination and would be detrimental to public confidence in the administration of justice (see
Rippon v Chilcotin Pty Limited (2001) 53 NSWLR 198 at [15]-[17], [31]-[32]).

246. The Taxpayers assert that, once the assets of the IEL Group, including those of GIH and its subsidiaries, had been realised, and the IEL Group effectively liquidated, it was inevitable that the proceeds of realisation would eventually be distributed by way of dividend or liquidation distribution and that the vast majority of the profits in GIH and its subsidiaries could only be distributed by way of unfranked dividends through Spassked. The Commissioner contends that such an assertion is an abuse of process. The decision to realise the assets held by companies in the IEL Group, and to liquidate the IEL Group, was taken, in substance, no later than December 1991, when the BT Plan was accepted by the Adsteam Committee. That occurred during the 1992 Year. Further, the first stage of implementation of the de facto liquidation occurred during the 1992 Year, namely, the lending of $2.1 billion by GIH to Spassked interest free. If Spassked's incurrence of further interest expense after that decision were to be regarded as falling within the first limb of s 51(1), the same must be true for the interest incurred during at least the second half of the 1992 Year. A finding to that effect would be in conflict with the conclusion reached in the Earlier Proceeding, as confirmed by the First Full Court.

247. The fact that the BT Plan had been adopted, and the fact that the IEL Group was in de facto liquidation pursuant to the BT Plan, were both before the Court in the Earlier Proceeding. Nevertheless, it was found, at least implicitly, in the face of that evidence, that the expectations and purposes with which Spassked had originally borrowed from IEF, being purposes not involving the derivation by Spassked of any income, continued up to 30 June 1992. That was inherent in, and central to, the determination of the Earlier Proceeding.

248. Since the Earlier Proceeding involved a determination in relation to the 1992 Year, it necessarily involved the conclusion that the non-income earning purposes and expectations that were found to have accompanied the implementation of the borrowings down to 28 June 1990, did not change up to 30 June 1992. The absence of explicit reference to that in the reasons for judgment in the Earlier Proceeding is explained by the circumstance that, in the Earlier Proceeding, Spassked did not contend that purposes or expectations had changed at any time between 30 December 1987 and 30 June 1994.

249. The approach of the First Full Court makes it clear that the decision in the Earlier Proceeding necessarily involved a finding that the original purpose of the borrowings continued into, and until the end of, the 1992 Year. The application of the Taxpayers' argument to the 1993 Year and the 1994 Year depends upon a finding that necessarily dates back to midway through the 1992 Year. That necessarily gives rise to conflict with the determination in the Earlier Proceeding. Hence it would involve an abuse of process. Further, the contention by the Taxpayers that Spassked could be regarded as carrying on business as a holding company, after a decision had been decided to liquidate the IEL Group, would be contrary to the findings made in the Earlier Proceeding, as confirmed by the First Full Court.

Conclusion as to deductibility

250. There are cogent reasons for concluding that the Taxpayers ought not be permitted to rely on the contentions outlined. However, for the above reasons, I do not consider that there was, in any of the 1991, 1993 or 1994 Years, any intention or expectation, on the part of those responsible for the decision as to whether to make assessable distributions to Spassked, that Spassked would, at any foreseeable time in the future, derive assessable income that could be referrable to the interest expenses that it was incurring to IEF in those Years.

251. The interest expenses incurred by Spassked in the 1991 Year and in the 1993 Year and the 1994 Year are not allowable deductions. It follows that there were no losses capable of transfer to IEF or QTH in the 1991 Year, the 1993 Year or the 1996 Year.

Part IVA

252. The Commissioner contends that, if the interest expenses incurred by Spassked in respect of its borrowings from IEF are otherwise allowable deductions for Spassked, the amounts claimed are not allowable, by reason of a determination made under s 177F of the Assessment Act. The Commissioner made such a determination on the basis of a scheme ( the Spassked Scheme ) formulated by the Commissioner as follows:

The Commissioner says that the parties to the Spassked Scheme were Spassked, IEL, IEF, GIH and the subsidiaries of GIH. Alternatively, the Commissioner relies on other schemes involving one or more of the elements described above. The parties to such schemes were Spassked and one or more of the other parties referred to above.

253. The Commissioner also relies on a determination under s 177F of the Assessment Act to deny deductions to QTH and IEF in respect of losses transferred to them by Spassked for the 1991 Year and the 1993 and 1994 Years respectively. The scheme in relation to IEF and QTH ( the Loss Transfer Schemes ) for each of those years was formulated by the Commissioner as involving each of the steps described above, together with the further step of the making of tax losses by Spassked and the transfer of those tax losses to other companies in the IEL Group, including IEF and QTH. The Commissioner says that the parties to those schemes were Spassked, IEL, IEF, GIH, GIH's subsidiaries and any other transferee of tax losses. Alternatively, the Commissioner relies on schemes involving one or other of the elements described above, together with the additional element of the making of tax losses and transfer of those tax losses to another company in the IEL Group. The parties to such alternative schemes were Spassked and the transferee companies or Spassked and the transferee companies together with one or more of IEL, IEF, GIH and the subsidiaries of GIH.

The alleged tax benefit

254. The Commissioner contends that the interest deduction claimed by Spassked in respect of the 1991, 1993 and 1994 Years would not have been allowable, or might reasonably be expected to not have been allowable, to Spassked in the relevant year, if the Spassked Scheme had not been entered into or carried out. The Commissioner says that none of a range of possible alternative structures that might have been entered into or carried out contemplated the incurrence of an interest expense by Spassked. The Commissioner says that the deduction is a tax benefit obtained by Spassked, within the meaning of s 177C of the Assessment Act.

255. The Commissioner says, further, that, had the Loss Transfer Schemes not been entered into or carried out, each of IEF and QIH would not have, or might reasonably be expected not to have, a deduction allowable equal in value to the tax losses transferred from Spassked pursuant to s 80G of the Assessment Act. The Commissioner says that it is a reasonable expectation that, if the Loss Transfer Schemes had not been entered into, allowable deductions equal to the tax losses received from Spassked would or might not have been allowable to IEF and QTH.

256. For the purposes of s 177D(b)(v) and s 177D(b)(vi) of the Assessment Act, the Commissioner relies on a report of Mr Stephen McClintock of 22 January 2002 ( the McClintock Report ). The McClintock Report was in evidence in the Earlier Proceeding and was admitted without objection in the Current Proceedings, together with other evidence relevant to the assumptions upon which the McClintock Report was based.

257. The McClintock Report is relied upon by the Commissioner as identifying the financial and taxation position that the members of the IEL Group would have been in, but for the implementation of the Spassked Structure. The Commissioner contends that the members of the IEL Group obtained the financial benefit identified in the McClintock Report as a result of entering into or carrying out the Spassked Scheme and the Loss Transfer Schemes.

258. Mr McClintock was asked to express his opinion on the financial and taxation position of each of the subsidiaries of GIH in the period 1 July 1987 to 30 June 1994 on the assumption that the Spassked Structure did not exist. In expressing his opinion Mr McClintock made certain assumptions that the Taxpayers accept. However, his report was also based on other assumptions that are challenged by the Taxpayers.

259. The assumptions made in the McClintock report included assumptions that the subsidiaries of GIH themselves would have borrowed, in lieu of Spassked, and would, therefore, have become dividend traps and that the dividends that were in fact credited to the subsidiaries of GIH during the relevant period would have been credited in any event, notwithstanding that they were dividend traps. On the basis of those assumptions, Mr McClintock considered that the net financial benefit to the IEL Group of the Spassked Structure lay in the fact that the Spassked Structure avoided the payment of dividends to dividend traps. He calculated that the financial and taxation benefit to the IEL Group was equal to the value of losses that would have been used, had dividends been paid to subsidiaries that were dividend traps. The total amount of dividends paid into dividend traps in the 1991, 1993 and 1994 Years was $153 million. The financial benefit was, in Mr McClintock's opinion, $59 Million in the 1991, 1993 and 1994 Years.

260. The Taxpayers challenge the assumption that dividends would have been paid into dividend traps if the Spassked Structure had not been implemented. The Taxpayers relied on evidence of Mr Cooper and Professor Officer that was given in the Earlier Proceeding and was also admitted without objection in the Current Proceeding. Mr Cooper said that Mr McClintock's assumptions did not accord with conduct to be expected of directors in the position of the directors of the IEL Group. He gave evidence of other options that would have been available to the directors. Professor Officer said that, if he had been commissioned to advise the IEL Group as to what steps it should take to address and alleviate the problems present at the time of the implementation of the Spassked Structure, he would have recommended a complete restructure of the IEL Group with a view to eliminating or reducing the number of actual or potential dividend traps that would have prevented the free flow of dividends within the IEL Group and that could have resulted in the wastage or a reduction in the value of dividend credits.

261. Mr Daniels gave evidence that Mr McClintock's assumptions were wrong. He said that, in each case where Mr McClintock assumed that, but for the Spassked Structure, a subsidiary of GIH that was a dividend trap would have received a dividend, either the relevant dividend trap would have been closed or, to the extent that the subsidiary remained a dividend trap and, to the extent that the companies from which the subsidiary received dividends were under the control of IEL, they would not have paid the dividend at the relevant time.

262. There was no oral evidence in the Current Proceedings from Mr McClintock, Professor Officer or Mr Daniels. Further, the Commissioner did not dispute any of the evidence adduced by the Taxpayers as to what might reasonably be expected to happen if the Spassked Structure had not been implemented. The Taxpayers say that, in those circumstances, the Court should conclude that the financial position of the members of the IEL Group would have been the same in the relevant years if the Spassked Structure had not been implemented. They say that, for the purposes of the comparison required by s 177D, there was relevantly no change in the financial position of any of the loss transferee companies. The non-wastage of tax losses, they say, would have occurred in any event, although the losses may have been located elsewhere in the IEL Group. Mr Daniels' unchallenged evidence was that the subsidiaries identified in the McClintock Report would either not have remained dividend traps or, if they had, would not have received the dividends.

263. The Taxpayers say that, in those circumstances, the Spassked Scheme did not give rise to a tax benefit and the losses that the Commissioner has disallowed would have been available to the loss transferees in any event. The Taxpayers also say that the non-wastage of tax losses is, in any event, not a tax benefit. Rather, they say, that is the very thing that the loss transfer provisions facilitated, namely, to ensure that tax losses were not wasted.

264. The Taxpayers say that the only financial or taxation benefit of the Spassked Structure, if any existed at all, was to place profitable subsidiaries in a position whereby they were able to enjoy the full benefit of the s 46 rebate. The benefit lay in being able to enjoy the rebate. However, to the extent that the Spassked Structure did deliver a benefit to the loss transferees that they might not otherwise have received (namely, to the extent that the Court accepts the Commissioner's contention that additional losses were available) the amount of any tax benefit cannot exceed the value of those additional losses. Section 177C requires that the tax benefit be calculated by comparing the benefits obtained with the benefits that would otherwise have been available if the relevant scheme had not been entered into. The Taxpayers say that, if that comparison yields any difference at all, which they deny, it could not exceed the amount of the additional losses referred to in the McClintock Report.

The matters in s 177D(b)

265. The Commissioner contends that, having regard to the factors listed in s 177D(b) of the Assessment Act, it would be concluded that Spassked, and any other relevant party to the Spassked Scheme, entered into and carried out the Spassked Scheme for the dominant purpose of enabling Spassked to obtain the deductions that it has claimed for interest expenses. The Commissioner says that it can also be concluded that IEF and QTH, and any other relevant parties to the Loss Transfer Schemes, entered into or carried out the Loss Transfer Schemes for the sole or dominant purpose of enabling IEF and QIH, as the case may be, to obtain the deductions arising from the transfer of tax losses by Spassked to them.

266. The Commissioner contends that the Spassked Scheme was entered into during the period from 30 December 1987 until 28 June 1990 and that it was the sole and dominant purpose of each of the relevant parties to enable Spassked, throughout the currency of the scheme, to make tax losses by incurring deductible interest expenses and not deriving assessable income. The Commissioner also contends that it was the sole or dominant purpose of each of the parties who carried out the Spassked Scheme in each of the 1991, 1993 and 1994 Years to enable Spassked, in each of those years, to make tax losses by incurring deductible interest and deriving assessable income. Finally, in relation to the Loss Transfer Schemes, the Commissioner contends that it was the sole or dominant purpose of each of the relevant parties to those schemes to enable the transferees of tax losses to obtain the benefit of the deductible losses transferred to them. It is convenient to deal separately with each of the eight factors described in s 177D(b).

The manner in which the Schemes were entered into or carried out

267. The Spassked Structure was devised and implemented by the tax section of IEL, which consisted of Mr Daniels, Mr Latham and Mr Cottam, together with the assistance of external advisers. The Spassked Structure was not documented and the borrowings from IEF were unsecured, being evidenced only by debits and credits in the books of companies in the IEL Group, together with some cheques and promissory notes. The timing of the borrowings and capitalisations and their quantum were determined by Mr Latham and Mr Cottam, who were tax managers of IEL. That is to say, the timing and quantum of the borrowings and the capitalisations were not responsive to decisions made by the investment team, which had responsibility for external investments.

268. The Spassked Structure and its implementation over the period of time by successive tranches had no impact on the ability of the IEL Group to make external investments. External acquisitions were being made regardless of the Spassked Structure. The capacity to make external acquisitions was dependent upon IEF being in a position to fund the acquisitions and not upon the equity subscribed by Spassked in GIH. The major takeovers during the period of the Spassked Scheme were of the Southern Farmers Group and of Woolworths, which were not funded by equity from GIH but from debt, the source of which was ultimately IEF. Spassked replaced other companies within the IEL Group that were dividend traps and the companies in which GIH invested ceased to be, or to have the potential of being, dividend traps.

269. The Taxpayers point out that the hypothesis upon which Part IVA is to be considered is that Spassked's interest expense was deductible under s 51(1), namely, that it was incurred in gaining or producing assessable income. They say that, on that hypothesis, the manner in which the Spassked Structure was implemented is unexceptional. It involved the intra-group recapitalisation of companies with a view to ensuring that Spassked, as an intermediate holding company in a large corporate group, would derive assessable income. The manner in which those arrangements were put in place does not, the Taxpayers say, point to the conclusion that any person's dominant purpose was to obtain interest deductions for Spassked.

The form and substance of the Schemes

270. The Commissioner says that the substance of the Spassked Scheme was to maximise the value of tax losses within the IEL Group and to enable dividends to be paid without being subsumed in dividend traps. The form of the Spassked Scheme was consistent with its substance. Thus, Spassked borrowed money at market rates of interest, which was capitalised. The borrowed funds were employed in the acquisition of shares in GIH and, in one instance, in a loan to GIH free of interest. Spassked's shareholdings in and loans to GIH produced no income for the relevant years of income, save for the payment of dividend on 30 June 1990 and 8 October 1991.

271. Spassked incurred significant tax losses by reason of the interest expense incurred to IEF without deriving any income in the relevant years. Those losses were transferred to other members of the IEL Group, including IEF and QTH, in order to reduce the taxable income of the transferees.

272. The funds borrowed by Spassked were channelled to the subsidiaries of GIH by way of equity subscriptions for shares in GIH. Dividends were paid to, and received by, other companies in the IEL Group, which, by reason of the channelling of equity funds through the Spassked Structure, were not dividend traps.

273. The position of Spassked as an intermediate company within the IEL Group cannot be explained from any external commercial point of view. It incurred interest on inter-company debt when its only asset was shares in GIH, a related company, from which it derived no income. It performed no role in relation to entities external to the IEL Group. The arrangements between the companies in question were inherently variable at the will of the directors of the Ultimate Parent Companies. The arrangements do not reflect the exercise of any business judgment in any relevant sense.

The time at which the Schemes were entered into and the length of the period during which the Schemes were carried out

274. The Spassked Scheme was devised and implemented following a number of amendments to the Assessment Act. First, s 80G, which permitted the transfer of losses within a group of wholly owned companies, was introduced in respect of the 1985 year of income. Subsequently, the dividend imputation regime was introduced in 1987.

275. At the time of implementation of the Spassked Structure, there was no plan or commitment as to how or when Spassked might cease to incur interest, which continued to be capitalised. Further, there is nothing about the Spassked Scheme that objectively discloses a time at which it would be wound up or terminated. The Spassked Structure could have continued on indefinitely. The Spassked Scheme continued until at least 1 July 1994, when Spassked ceased to be a dividend trap. Nevertheless, Spassked continued to transfer losses to other members of the IEL Group until 1 July 1997. During the entire period, Spassked derived no dividends, save for the two dividends in June 1990 and October 1991.

276. The Taxpayers say that the introduction of the dividend imputation system increased the pressure on companies to pay franked dividends to shareholders. That was an important concern that the Spassked Structure was intended to address. Further, the closure of the Spassked dividend trap was identified as an objective as early as the 1991 Year and was pursued over several years until Spassked's borrowings from IEF were finally repaid by 1 July 1994. The Taxpayers say that those factors point against a conclusion that any person's dominant purpose was to obtain interest deductions for Spassked.

The result in relation to the operation of the Assessment Act that would be achieved by the Schemes

277. If the interest expenses constitute allowable deductions, the result would be that Spassked would be entitled to deductions for the whole of the capitalised interest incurred by it in respect of its borrowings from IEF in the 1991, 1993 and 1994 Years. The interest and consequential tax losses of the relevant years would be as follows:

Year Interest Tax Loss
1991 $774,746,526 $774,746,571
1993 $465,626,741 $465,626,785
1994 $79,284,023 $77,051,412

278. The Taxpayers say that, but for the operation of Part IVA, the result was that Spassked incurred interest expense on borrowings that it used to invest in profitable businesses. It alone was entitled to those profits for the benefit of its own shareholders. Those profits have been realised and the proceeds have been lent to Spassked's ultimate owners, on the express understanding that, in due course, the profits will be distributed by way of dividend, thus repaying the loans. IEF returned the interest expense charged to Spassked as assessable income and, on the hypothesis in question, Spassked was entitled to allowable deductions for its expense in making the profitable investment in GIH. The Taxpayers say that the results are entirely unremarkable.

Any change in the financial position of Spassked that will result from the scheme

279. Spassked borrowed $3,762,756,243 in total and the interest incurred in relation to those borrowings from 1987 to 1994 was $3,272,715,111. Spassked received only unfranked dividends in the sum of $29,308,093 on 30 June 1990 and $14,654,046 on 8 October 1991. However, during the period of the Spassked scheme, from 30 December 1987 to 30 June 1994, Spassked suffered losses totalling $3,251,952,899. Had the Spassked Scheme not been entered into, Spassked would not have incurred interest to IEF and would not have sustained the losses.

280. The Taxpayers say there was no relevant change in the financial position of the IEL Group as a result of the implementation of the Spassked Structure. The supposed financial benefit identified in the McClintock Report was the saving or non-wastage of tax losses that were available within the IEL Group anyway and that would have been preserved by various means in any event. They say that, to the extent that the Spassked Structure affected the financial position of Spassked, in that it gave rise to deductions for interest expenses, those effects were balanced by a change in the financial position of IEF, which derived assessable income. Spassked's financial position improved in line with the fund of profits generated in the subsidiaries of GIH. Finally, to the extent that the Spassked Structure affected the financial position of loss transferees, those transferees would have been entitled to losses in the same amount in any event.

Any change in the financial position of any person who has or has had any connection with Spassked

281. The financial position of the subsidiaries of GIH improved as a result of the Spassked Scheme. Their exposure to interest bearing inter-company debt was extinguished or reduced. They were able to receive dividends in respect of which they obtained a tax rebate for an amount that was greater than the amount they would have received on dividends had the Spassked Scheme not been entered into. Their taxable income increased but no tax was paid by reason of the availability of the rebate under s 46 of the Assessment Act.

282. IEL received franked dividends of $33,378,828. IEF returned interest income from Spassked. Whether IEF's financial position changed as a result of the Spassked Scheme depended upon whether it would have received the same level of interest income from other members of the IEL Group had the Spassked Scheme not been entered into.

283. The financial position of the transferees of the tax losses improved as a result of the maximising of tax losses in Spassked that were available for transfer to them. During the period from 1987 to 1997, Spassked transferred all of its available tax losses.

284. The Commissioner contends that the financial impact of the transfer of the tax losses is to be determined by comparing the quantum of tax losses incurred and then grouped by Spassked during the period, with the tax losses that would have been available to companies in the IEL Group on the assumption that they had themselves borrowed money in order to fund acquisitions and receive the dividends that they actually did receive during the period. In general terms, the difference represents the amount of tax losses available to be transferred to other members of the IEL Group, due to the quarantining of rebateable dividend income from the incurrence of interest, which otherwise would have been lost due to the receipt of rebateable dividends. The quantum of tax losses for the period 1980 to 1994 was $326,253,589. The Commissioner contends the actual financial benefit is the tax value of those losses, namely, $126,894,028.

285. The Spassked Scheme had no impact on the ability of the IEL Group to make external investments, which would have been made regardless of the Spassked Structure. The capacity of GIH and its subsidiaries to make external acquisitions was dependent upon IEF being in a position to fund the acquisitions and not upon the funds subscribed by Spassked for shares in GIH. The major acquisitions during the period of the Spassked Scheme, being the Southern Farmers Group and Woolworths, were not funded by equity from GIH but from debt, sourced ultimately from IEF.

Any other consequences for Spassked or any person having a connection with Spassked

286. The Commissioner does not suggest that there were any other non financial consequences for Spassked or for any other person having any connection with Spassked, of the Spassked Scheme having been entered into or carried out.

The nature of any connection

287. All of the parties to the Spassked Scheme were wholly owned subsidiaries of IEL. Spassked and GIH had common directors during the period, with minimal exceptions, and the same directors constituted the boards of the subsidiaries of the IEL Group who were parties to the Spassked Scheme.

Conclusion as to Part IVA

288. On the assumption that the interest expenses incurred by Spassked in the 1991, 1993 and 1994 Years would otherwise be allowable deductions, it is certainly arguable that Part IVA would not apply in respect of either the Spassked Scheme or the Loss Transfer Schemes. However, having regard to the conclusion I have reached concerning the deductibility of the interest expenses, it is unnecessary to reach a conclusion in relation to the application of Part IVA.

Additional tax

289. The Taxpayers also complain about assessments for additional tax. The Taxpayers have adduced all of the evidence relevant to the question of additional tax. However, the Taxpayers and the Commissioner have joined in requesting the Court to defer consideration of issues relating to the imposition of additional tax until the questions as to the deductibility of Spassked's interest expenses and the transferred tax losses have been determined.

Conclusion

290. The appeals should be dismissed in so far as they challenge the disallowance of the deductions claimed by the Taxpayers in the relevant Years. It will now be necessary to consider the question of the imposition of additional tax, in the light of that conclusion.

 

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.