The impact of this case on ATO policy is discussed in Decision Impact Statement: Orica Ltd v Commissioner of Taxation (VID 43-48 of 2015 ).
ORICA LTD v FC of TJudges:
Federal Court, Melbourne
MEDIA NEUTRAL CITATION:
 FCA 1399
1. The principal issue in these proceedings is whether s 177D of Part IVA of the Income Tax Assessment Act 1936 (Cth) ("the 1936 Act") applies to three schemes by which deductions for interest were claimed by Orica Finance Limited (which will be referred to as "OFL" or "the finance company") in each of the 2004 to 2006 income years. The deductions were claimed for interest incurred on loans from transactions which the parties in these proceedings agreed fall within the meaning of "scheme" in Part IVA in connection with which the taxpayer obtained "tax benefits" within the meaning of s 177C(1)(b). Two other issues arise in the proceedings if Part IVA applies to cancel the deductions, namely, whether administrative penalties are to be imposed under s 284-145 of Schedule 1 to the Taxation Administration Act 1953 (Cth) ("the Administration Act") and, if so, whether they are to be reduced under s 284-160 on the basis that the position taken by the taxpayer that Part IVA did not apply was reasonably arguable.
2. The relevant taxpayer is Orica Limited ("Orica") as the head entity of a consolidated group within the meaning of Part 3-90 of the Income Tax Assessment Act 1997 ("the 1997 Act"). The finance company was an Australian subsidiary of the Orica group which borrowed funds in the years in question from Orica US Services Inc (which will be referred to as "OUSSI" or "the US subsidiary"). OUSSI was incorporated and resident in the United States of America and was a wholly owned subsidiary of Orica Explosives Holdings Pty Ltd ("OEH") which, in turn, was a wholly owned subsidiary of Orica. OEH was incorporated and resident in Australia and was the holding company for Orica's US group of companies.
3. The years in dispute are those for Orica's substituted accounting periods ending 30 September for 30 June for each of 2004, 2005 and 2006. Orica had a substituted accounting period ending 30 September in lieu of 30 June. In each of those years Orica claimed deductions under s 8-1, or alternatively s 25-90, of the 1997 Act as head company of the Orica Limited tax consolidated group (which had been formed on 28 August 2003) for interest incurred by the Australian finance company on loans from the US subsidiary. The interest was claimed as a deduction by the finance company in the period before consolidation of the group, namely from 27 May 2002 to 28 August 2003. The schemes did not result in a reduction of tax payable in the 2002 income year because, at the time, OFL had tax losses and no taxable income, although its assessment for the 2002 year was subsequently amended in 2006 showing a taxable income of $6,459,499. In the 2003 income year, for the period up to the end of 27 August 2003, the group had total carry forward losses of approximately AUD$112 million (exclusive of any deduction claimed by OFL for interest incurred to the US subsidiary). The deduction for interest payable by OFL to the US subsidiary for the period 28 August 2003 to 30 September 2003 resulted, at the time, in a small reduction of Australian tax payable of approximately $137,250. OFL's assessment for the 2003 year was also subsequently amended to show a taxable income of $22,851,200, but that assessment is not the subject of dispute in these proceedings. What is in dispute is the tax assessed to Orica in the 2004 to 2006 years under Part IVA of the 1936 Act and the corresponding assessments to Orica for scheme shortfall penalties under s 284-145 of Schedule 1 to the Administration Act. In each case Orica was assessed as head company under Part 3-90 of the 1997 Act and no issue was taken by either party about the Commissioner's ability to
ATC 18180do so under Part IVA of the 1936 Act other than because of s 177D. The parties otherwise agreed that ss 177C and 177F applied: cf
Channel Pastoral Holdings Pty Ltd v Federal Commissioner of Taxation  FCAFC 57.
4. The background to the relevant transactions was largely explained in the evidence of Mr Adrian Muculj who was, at the time relevant to these proceedings, the general manager of taxation at Orica and the person responsible for the tax functions for Orica and its subsidiaries in Australia and in the other countries in which Orica and its subsidiaries operated. He was appointed to that position in October 2001 and assisted in finalising the financial accounts for the financial year ending 30 September 2001. Orica's financial position at that time was described by Mr Muculj as "very poor, especially in relation to the North American explosives business". Orica's share price had fallen to around $4 and the board's audit and risk committee had approved a large write down of the carrying values of the North American explosives business because of poor financial performance. The write down included the estimated value of US future income tax benefits arising from the potential future use of past US tax losses which had been incurred by the US subsidiary. The preliminary results for the 2001 financial year released to the Australian Securities Exchange in November 2001 reported a loss of $192.7 million after tax compared with a profit of $113.7 million in the previous year.
5. The Orica group had unbooked US tax losses valued at AUD$52.9 million as at 30 September 2001. Tax losses may be an asset for an enterprise if it is able to use those losses in subsequent years to reduce the tax payable on subsequent profits but the Orica group was unable to use its US tax losses and, therefore, could no longer record them as assets. Orica's unbooked US tax losses had previously formed part of the assets recognised in the Orica group's consolidated balance sheet (called the statement of financial position) and had been taken into account as a reduction in the group's income tax expense in the consolidated profit and loss statement (called the statement of financial performance), but the US tax losses had subsequently been written down because the US business was unlikely to utilise them given its poor performance and its poor future prospects. The evidence of Mr Muculj was that Australian Accounting Standard AASB 1020 in 2001 provided that the future benefit of tax losses could be recognised as long as it was "virtually certain" that the losses would be used in the future. At that time there was no such prospect and, therefore, the US tax losses could not be recognised in the accounts as an asset. The inability to recognise the tax losses in the books did not mean that they could not be utilised to reduce future tax payable by the US subsidiary which had those losses if taxable income came to be derived by that company, but that they could not be recorded in the books as an asset.
6. The recognition of tax losses in a company's accounts has an impact upon the report of future profits from an accounting point of view. That is due to the accounting entries which are needed to record the effect of past losses upon future profits. The entries needed to recognise the benefit of past tax losses include a debit entry for a future income tax benefit in the balance sheet (recording an asset) and a corresponding credit entry to the income tax expense account in the profit and loss statement (recording a reduction in tax payable). The reduction in the income tax expense account in the profit and loss statement has the effect, for accounting purposes, of increasing reported earnings. The accounting entries to record the effect of the use of the future income tax benefit once income is derived include entries to record the income and those which reduce the previously recorded asset. Therefore (a) the income tax expense account is debited with a corresponding credit in the balance sheet to recognise the income tax liability, and (b) the future income tax benefit in the balance sheet is reduced by a credit entry and a corresponding liability for income tax in the balance sheet is decreased by a debit entry.
7. In late 2001 Mr Muculj, and others on behalf of Orica and its subsidiaries, explored ways in which the US tax losses could be "rebooked" with the ultimate objective of increasing Orica's reported consolidated profits that would result, in part, by a reduction in the income tax expense account in Orica's consolidated group accounts. On 4 December 2001 Mr Muculj met with Mr Bill
ATC 18181Reynolds and Mr Peter Collins to consider how the US losses could be utilised by the group. Mr Reynolds was a senior tax manager at Orica and Mr Collins was a tax partner with PriceWaterhouseCoopers who were Orica's tax advisers. Mr Muculj told Mr Collins at that meeting that Orica had a significant amount of unbooked tax losses in the United States and that it may be possible to re-recognise the value of those losses by generating income in the United States against which the losses could be used. Mr Collins said that a possible option would be to use external bank funding to invest equity into Orica's US business and to put those funds on deposit with the same bank with the aim of generating interest income in the United States. The three met again the following week to discuss some of the financing options they had previously considered. Variations to the proposal were considered but all were directed to the use of the US tax losses of the US subsidiary. An element of that use involved the re-recognition, or rebooking, of the US tax losses to be set off against the income to be generated by the proposal.
8. The initial proposals considered by Mr Muculj contemplated, as mentioned above, the use of external borrowings to be employed by the US subsidiary to derive income from other members of the Orica group, but the use of external borrowing was subsequently substituted by wholly internal financing. At a meeting on 18 January 2002 with Mr Reynolds and Mr Collins, Mr Muculj said that the cost and inconvenience of external funding for each leg of the proposal was unnecessary and could be eliminated by having OFL provide the necessary funds. In February 2002 Ms Jackie Bottomley, a member of Orica's finance group, asked Mr Muculj to complete a description of the proposal of utilising the US tax losses for presentation to an Orica group executive meeting. Ms Bottomley was a member of a project team within Orica's head office in Australia which had been looking for opportunities to increase profits across the Orica group. In February Mr Muculj completed a draft "initiative action template" and presentation slides which he provided to Ms Bottomley. The initiative action template provided by Mr Muculj to Ms Bottomley was dated 8 February 2002 and described the initiative (named "Utilisation of US Tax Losses") as being to "realise reduced tax charges through utilisation and recognition of US tax losses by implementing a more effective financing structure". Mr Muculj was described in the template as the project manager and the template identified the key steps as being to borrow funds in New Zealand and Canada to place them on deposit in the USA via Australia. The objectives in the accompanying slides were described as being to generate taxable income in the USA and to maximise gearing in certain jurisdictions. All of the borrowings which were contemplated at that stage from Canada and New Zealand were to be sourced from OFL for investment in the USA via Australia through wholly intra company transactions.
9. Mr Muculj's discussions with others within Orica also considered how much of the losses should be rebooked over time by the proposed structure. The proposal discussed on 18 January 2002 was to spread the increase in profits over a number of years to avoid having the increased profits being treated in its published accounts as a non-recurring significant item. On 9 January 2002 Mr Collins had suggested that the refinancing structure could possibly be enhanced by rebooking the value of tax credits arising from the re-recognition of the US tax losses over a period of time extending to three years to smooth the increase in profits. Subsequently Mr Muculj expressed a concern to Mr Reynolds that rebooking two years' worth of the benefit of tax losses in one year might need to be treated in the published accounts of Orica as a significant non recurring item which the market might discount and that, therefore, there was benefit in the suggestion which Mr Collins had made of spreading the rebooking of the losses "over a longer period as a way of enhancing the reported profits of the Orica group over time".
10. The structure put in place to utilise the US tax losses assumed, as was the case, that they could not otherwise have been utilised by the US subsidiary by its normal trading. The initiative action template dated 8 February 2002 prepared by Mr Muculj expressly stated that normal trading would not increase to utilise substantially the US tax losses. On 18 April 2002 Mr Muculj gave a presentation to the members of Orica group's executive
ATC 18182about the group's overall tax strategy, noting that the North American businesses had significant unbooked tax losses which had previously been recognised in the published accounts but had been written off in 2001. He informed the group's executive that one of the items "for consideration was how to generate sufficient assessable income in the US to justify a re recognition in the accounts of the benefit of these US tax losses". He told the group's executive members that the proposal under consideration involved a subscription of equity by one of Orica's (Australian) subsidiaries, namely, OEH, in its US subsidiary with the US tax losses. The proceeds of the proposed subscription in the US subsidiary would be put on deposit with the finance company in Australia to generate, from the interest payable by the finance company to the US subsidiary, interest income that would be assessable to the US subsidiary in the United States, and interest expense that would be deductible to OFL in Australia. Mr Muculj explained to the executives that a re-recognition of the US tax losses would cause an increase of the profits in Orica's reported consolidated statement of financial performance but that there would be no increase in the reported earnings without the re recognition of the tax losses which had been written off. Rebooking the losses in Orica's accounts, as explained above, was not required to utilise the unbooked tax losses but their rebooking would have an impact on the reported profits. The proposal did not involve the US subsidiary deriving income from sources external to the Orica group or from its ordinary business operations with third parties.
11. The proposal was adopted by Orica and implemented over time in three tranches each of which was identified by the Commissioner as a scheme within the meaning of Part IVA of the 1936 Act. Emails were sent in May 2002 to the relevant people responsible for the actions of each of the Canadian, US and New Zealand subsidiaries of Orica to pass board resolutions authorising entering into the arrangements. On 28 May 2002 Orica's assistant company secretary, Ms Susan Howard, sent the board papers, notices and draft minutes of board meetings to the directors of the Australian Orica subsidiaries which were required to pass board resolutions to approve the transactions and to execute the necessary loan facility agreements. The US, Canadian and New Zealand legs of the refinancing were authorised by the respective boards on 31 May 2002. The key elements of the Australian leg of the proposed structure for present purposes involved (a) a transfer of funds from the (Australian) finance company to an (Australian) Orica subsidiary (OEH) holding shares in the US subsidiary with US tax losses, (b) the application by OEH of the funds borrowed from the finance company in the acquisition of redeemable preference shares in the US subsidiary with the tax losses, and (c) the use of the funds received by the US subsidiary on the issue of the redeemable preference shares to lend to the (Australian) finance company at interest to the extent available after discharging pre-existing unpaid borrowings. The net tax consequences of the transactions, in broad terms, included deductions to the Orica group in Australia for the interest payable by the finance company to the US subsidiary, a US withholding tax liability for the interest payable by the finance company to the US subsidiary, and the utilisation of the US tax losses to the extent of the income derived by the US subsidiary from the interest payable by the finance company.
12. The documents giving effect to the proposal included a memorandum from Mr Reynolds dated May 2002 describing the proposal in general terms as a borrowing by OEH of the Australian dollar equivalent of USD$265 million from the Australian finance company for OEH to subscribe and to pay for non-cumulative redeemable preference shares of USD$265 million to be issued by its wholly owned US subsidiary with the relevant US tax losses. The amount of USD$265 million lent by the finance company to OEH was at a rate of interest determined in accordance with Orica's Group Global Treasury Guidelines. OEH then subscribed for 265 Series B Redeemable Preference Shares in the US subsidiary at a price of USD$1 million per share. The US subsidiary used part of the subscription proceeds it received to lend to the finance company an amount of USD$192,101,200 for a term of nine years at a fixed rate of interest of 5.43% per annum pursuant to a written loan facility agreement dated 31 May 2002. The remaining capital was used by
ATC 18183the US subsidiary to discharge its obligations under earlier loans from the finance company. A second tranche of similar transactions was entered into around 24 October 2003 and a third tranche of similar transactions was entered into around 12 July 2004. Each tranche of the transactions resulted in the rebooking in short form accounting of the unbooked US tax losses in the accounts, the utilisation of unbooked US tax losses by the US subsidiary, an increase in Orica's reported earnings, the incurring of interest obligations by the finance company to the US subsidiary pursuant to the facility agreements executed in each year and the remission by the finance company of Australian withholding tax payable by the US subsidiary in respect of the interest earned by it from its placement of funds on deposit with the finance company. The accounting of the transactions in short form did not record all of the entries in the accounts, but it may be accepted that they recorded an increase in accounting profits resulting from a rebooking of the US tax losses.
13. The Commissioner contends, and Orica accepts, that the transactions effected by the three tranches gave rise to three schemes within the meaning of Part IVA of the 1936 Act. Each of the three schemes is materially the same and calls for consideration of predominantly the same matters. The first scheme identified by the Commissioner was as follows:
- (a) On 31 May 2002, OEH subscribed for 265 redeemable preference shares in OUSSI (known as the Series B RPS) at an issue price of USD$1 million per share. The Series B RPS conferred on OEH a right to receive a non cumulative annual dividend payable out of distributable profits at a rate of 8.55% of the issue price in preference to holders of common stock, but subordinated in right of payment to pre-existing redeemable preference shares (known as the Series A RPS);
- (b) On 31 May 2002, OUSSI loaned USD$192,101,200 to OFL pursuant to a facility agreement dated 31 May 2002 for a term of nine years at a fixed interest rate of 5.43% per annum;
- (c) On 4 June 2002, OUSSI applied the balance of the USD$265 million from the Series B RPS, being USD$72,898,800 to repay a pre-existing loan from OFL; and
- (d) On 4 June 2002, OFL loaned AUD$460,869,565 (being the AUD equivalent of USD$265 million) to OEH pursuant to a facility agreement dated 31 May 2002 at an interest rate developed using the Orica Group Global Treasury Guidelines.
The second scheme identified by the Commissioner relevantly involved the following:
- (a) On 30 October 2003, OEH subscribed for 150 redeemable preference shares in OUSSI (known as the Series C RPS) at an issue price of USD$1 million per share. The Series C RPS conferred on OEH a right to receive a non cumulative annual dividend at a rate of 7.53% of the issue price - when, if and as declared by the board of directors - in preference to holders of common stock, but subordinated in right of payment to the Series A and Series B RPS;
- (b) On 30 October 2003, OUSSI loaned USD$150 million to OFL pursuant to a facility agreement dated 30 October 2003 for a term of nine years at a fixed interest rate of 4.46% per annum; and
- (c) On 3 November 2003, OFL loaned AUD$211,744,777 (being the AUD equivalent of USD$150 million) to OEH pursuant to the facility agreement dated 31 May 2002 at an interest rate developed using the Orica Group Global Treasury Guidelines.
The third scheme identified by the Commissioner comprised the following:
- (a) On 15 July 2004, OEH subscribed for 175 redeemable preference shares in OUSSI (known as the Series D RPS) at an issue price of USD$1 million per share. The Series D RPS conferred on OEH a right to receive a non cumulative annual dividend - when, if and as declared by the board of directors - at a rate of 7.87% of the issue price in preference to holders of common stock, but subordinated in right of payment to the Series A, Series B and Series C RPS;
- (b) On 15 July 2004, OUSSI loaned USD$175 million to OFL pursuant to a
ATC 18184facility agreement dated 15 July 2004 for a term of nine years at a fixed interest rate of 4.95% per annum; and
- (c) On 15 July 2004, OFL loaned AUD$241,779,497 (being the equivalent of USD$175 million) to OEH pursuant to a facility agreement dated 12 July 2004 at an interest rate developed using the Orica Group Global Treasury Guidelines.
Each of the three schemes gave rise to tax deductions for the interest payable by OFL to OUSSI which Orica conceded to be tax benefits within the meaning of s 177C(1)(b).
14. OUSSI derived a total of USD$80,364,765 in interest income between 27 May 2002 and 25 August 2006 on its loans to OFL from funds acquired by OUSSI from OEH from the money lent to OEH by OFL. OUSSI utilised USD$80,806,897 in tax losses to offset against its income for US tax purposes. The interest payable by OFL to OUSSI was subject to Australian non resident withholding tax at a rate of 10% which OUSSI was able to claim as a tax credit in the United States equal to the Australian withholding tax paid to the Commissioner. The withholding tax amounts paid were $634,694 in 2002, $1,758,727 in 2003, $2,481,723.10 in 2004, $3,321,656.80 in 2005, and $3,061,682.80 in 2006. The amount of interest claimed as deductions by Orica in each of the years in dispute was summarised by the Commissioner as follows:
|Income Year||Scheme 1||Scheme 2||Scheme 3||Total (AUD)|
OUSSI had utilised its available US tax losses by August 2006 and on 25 August 2006 (a) OFL paid USD$625,840,500 to OUSSI in discharge of the loans, (b) OUSSI paid a dividend to OEH of USD$48,999,338 on the Series B RPS, (c) OUSSI paid USD$590,000,000 to OEH to redeem the Series B, C and D redeemable preference shares, and (d) OEH paid AUD$841,563,727 to OFL in partial discharge of the loans which OFL had previously made to OEH. The balance of the loans was discharged by OEH on 19 December 2006.
15. The Commissioner contended, and Orica conceded, that the tax deductions claimed for the interest incurred by OFL in each of the three years in question were tax benefits within the meaning of s 177C(1)(b) and that they had been obtained in connection with schemes within the meaning of Part IVA. The field of dispute between the parties, therefore, concerned the application of s 177D of the 1936 Act. That section provided in the relevant income years:
177D Schemes to which Part applies
This Part applies to any scheme that has been or is entered into after 27 May 1981, and to any scheme that has been or is carried out or commenced to be carried out after that date (other than a scheme that was entered into on or before that date), whether the scheme has been or is entered into or carried out in Australia or outside Australia or partly in Australia and partly outside Australia, where:
- (a) a taxpayer (in this section referred to as the relevant taxpayer ) has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme; and
- (b) having regard to:
- (i) the manner in which the scheme was entered into or carried out;
- (ii) the form and substance of the scheme;
- (iii) the time at which the scheme was entered into and the length of the period during which the scheme was carried out;
- (iv) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme;
- (v) any change in the financial position of the relevant taxpayer that has resulted,
ATC 18185will result, or may reasonably be expected to result, from the scheme;
- (vi) any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme;
- (vii) any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out; and
- (viii) the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (vi);
it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for the purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme or of enabling the relevant taxpayer and another taxpayer or other taxpayers each to obtain a tax benefit in connection with the scheme (whether or not that person who entered into or carried out the scheme or any part of the scheme is the relevant taxpayer or is the other taxpayer or one of the other taxpayers).
Orica contended that having regard to the matters set out in s 177D(b) it would not be concluded that any participant in the schemes entered into or carried out the schemes, or any part of the schemes, for the purpose of enabling the relevant taxpayer to obtain the tax deductions in connection with the schemes.
16. Orica's submissions placed emphasis upon the purpose of the schemes as being the re recognition for accounting purposes of the benefit of the US tax losses. In that connection Orica relied upon the joint expert report of Mr Kevin Stevenson AM and Mr Chris Holland which was tendered in evidence. Mr Stevenson of Stevenson McGregor had previously been engaged on behalf of Orica to provide opinions on a number of questions concerning the accounting treatment of the schemes. Mr Holland of Sapere Forensic had previously provided an expert opinion on behalf of the Commissioner in which he had disagreed with some aspects of Mr Stevenson's opinions. The joint report set out the matters on which they agreed and disagreed. A matter upon which they agreed, and which had not required the resolution of differences between the experts, was that journal entries provided to Mr Stevenson and Mr Holland for their opinion and report showed that the cumulative effect of the transactions in question over Orica's 2002 to 2006 income years was a cumulative increase in the consolidated profit of the Orica group of A$33.8 million. The experts agreed, therefore, unsurprisingly, that the effect of the transaction over that period had a cumulative positive economic benefit for the Orica group. The amount in question was based upon the facts which the experts were asked to assume and to that extent may not correspond precisely with the net cumulative increase after adjustment for, for example, entries relating to the payment and remittance of withholding tax. However, the amount of the increase in the reported profit was essentially the amount by which Orica's group tax was reduced after claiming deductions in Australia for $112.5 million as interest expenses incurred by OFL. Orica's submissions, however, placed emphasis upon the importance of rebooking of the US tax losses in the amounts (albeit in short form) in the reported profits.
17. At paragraph 7 of the joint report the experts explained their agreement that the accounting components of the cumulative increase in the consolidated profit of the Orica group were:
- (a) a cumulative reduction of $33.8 million in the income tax expense recognised in the consolidated profit and loss statement resulting from a deduction (at a 30% tax rate) for income tax purposes of the $112.5 million in interest expense incurred by OFL on loans from OUSSI;
- (b) a cumulative increase of $45 million in the income tax expense of OUSSI resulting from the assessability (at a 40% tax rate) of the interest income of $112.5 million it received from OFL; and
- (c) a cumulative reduction in the income tax expense of OUSSI, equivalent to the increase in (b) above, resulting from the bringing to account in each period of the "un-booked" benefits of tax losses at the beginning of each of those periods.
Appendix F to Mr Stevenson's report (attached to the joint report) summarised the comparative impact to the accounts of a taxpayer having written off tax loss benefits when subsequently found to be realisable with the accounts of (a) a taxpayer that had no such tax benefits and (b) a taxpayer with the benefits booked but not having been written off. The summary shows that the "actual" transactions and events had a positive impact upon the accounting consolidated profit of Orica that would not have been reported by the same transactions if Orica either (a) had no tax losses available to utilise or (b) had booked the benefits but had not previously written them off. It may not be surprising that the three scenarios would produce different accounting consequences because, in the first of the comparisons, the increased profits would not have been sheltered from tax by the benefit of available tax losses, and in the second of the comparisons, the accounts would have reflected the tax losses as an income tax expense in prior years.
18. The application of s 177D, however, does not depend upon the ultimate economic purpose of those who entered into or carried out the schemes which enabled the taxpayer to obtain the tax benefits. Orica's written submissions correctly accepted as much when stating that the case was not about "a company's ultimate economic purpose, and of subordinating the role tax benefits may play, as against that purpose". The written submissions correctly acknowledged that "[e]stablishing that the dominant purpose of a scheme is to obtain the maximum economic return, taking tax into account, does not prevent the application of Part IVA". Part IVA was applied in
Federal Commissioner of Taxation v Spotless Services Ltd (1996) 186 CLR 404 to a scheme which had as its ultimate economic purpose the derivation of interest income by the taxpayer from an unrelated third party and which had produced an after tax commercial benefit for the taxpayer. In that case the shape of the commercial transaction was found to require the conclusion necessary for Part IVA to apply notwithstanding the ultimate economic purpose or after tax commercial benefit. At 416 the Court said:
A taxpayer within the meaning of the Act may have a particular objective or requirement which is to be met or pursued by what, in general terms, would be called a transaction. The "shape" of that transaction need not necessarily take only one form. The adoption of one particular form over another may be influenced by revenue considerations and this, as the Supreme Court of the United States pointed out, is only to be expected. A particular course of action may be, to use a phrase found in the Full Court judgments, both "tax driven" and bear the character of a rational commercial decision. The presence of the latter characteristic does not determine the answer to the question whether, within the meaning of Pt IVA, a person entered into or carried out a "scheme" for the "dominant purpose" of enabling the taxpayer to obtain a "tax benefit".
Federal Commissioner of Taxation v Consolidated Press Holdings Ltd (2001) 207 CLR 235 the High Court similarly upheld the application of Part IVA to the interposition of a scheme in a flow of funds ultimately directed to the commercial objective of participation in a takeover bid in the United Kingdom. The application of Part IVA was subsequently upheld in
Federal Commissioner of Taxation v Hart (2004) 217 CLR 216 to a transaction which had the ultimate commercial purpose of securing, and which did secure, a loan from a third party for the purchase of property. The fact that Orica may likewise have had a commercial objective for entering into the schemes, and may have achieved that objective, does not necessarily exclude the application of Part IVA to the schemes.
19. The application of s 177D requires, rather, having regard to the eight matters in s 177D(b) to determine whether "it would be concluded" from those matters that a person who entered into or carried out the scheme did so for the dominant purpose of enabling the taxpayer to obtain a tax benefit in connection
ATC 18187with the scheme. The conclusion to be reached is not a finding on the evidence that one of the persons contemplated by the section had the requisite purpose but that such a purpose is to be attributed to one of those persons by analysis of objective criteria without regard to the actual purpose or motive, ultimate or otherwise, of the relevant scheme participants: Spotless Services at 415; Consolidated Press Holdings at 264  and ; Hart at 222 , 227  and 243 . Thus, for example, the inquiry called for by s 177D is not answered in the Commissioner's favour by evidence of the description of the proposal as found in the 8 February 2002 initiative action template that the proposal would "[r]ealise reduced tax charges through utilisation and recognition of US tax losses". The actual motive may explain why the taxpayers "acted as they did" but, as Gummow and Hayne JJ observed in Hart at 243 , it does not provide an answer to the question posed by s 177D(b) which "does not require, or even permit, any inquiry into the subjective motives of the relevant taxpayers or others who entered into or carried out the scheme or any part of it". The specific delineation of the inquiry by s 177D(b) to determine an objective conclusion about purpose may be contrasted with the broader and inclusive inquiry called for by s 177EA(3)(e) about the dominance of actual purposes of a taxpayer in the context of imputation credits: see
Mills v Federal Commissioner of Taxation (2012) 250 CLR 171, 201-2 , 206 -.
20. The parties agreed, in my view correctly, that the conclusion called for by s 177D about dominant purpose did not depend upon considerations about alternatives that may need to be considered to determine whether a taxpayer obtained a tax benefit under the former terms of s 177C. In this case Orica had in any event conceded that it had obtained tax benefits making it analytically inappropriate to consider alternatives in the context of s 177D by which it did not obtain tax benefits within the meaning of s 177C. The conclusion contemplated by s 177D calls for an evaluative judgment. It is to that extent similar to the evaluative judgment contemplated by the predication test in
Newton v Federal Commissioner of Taxation (1958) 98 CLR 1, 8-9. The evaluative judgment to be made under s 177D about dominant purpose is one to be made by application of the words of s 177D and, specifically, by having regard to the matters to which the section compels, and confines, attention. It is by a consideration of those matters that the conclusion is to be made about whether obtaining the tax benefit was the "ruling, prevailing, or most influential purpose": Spotless Services at 416; see also at 423. The dominant purpose of obtaining a tax benefit may be revealed, as was decided in Spotless Services, by "the particular means adopted by the taxpayers to obtain the maximum return on the money invested after payment of all applicable costs, including tax": Spotless Services at 423. It may also be revealed by consideration "of what other possibilities existed" by reference to the eight matters in s 177D(b): Hart at 243 ; see also
British American Tobacco Australia Services Ltd v Federal Commissioner of Taxation (2010) 189 FCR 151, 163, . In Hart the dominant purpose of obtaining a tax benefit could be seen by comparing what was done to borrow funds with how else funds could be borrowed, and, therefore, as in Spotless Services, the dominant purpose was revealed by consideration of the eight factors in s 177D(b) in the particular means adopted by the taxpayer. It is not relevant to consider, therefore, whether Orica might have done something else, such as to borrow funds from an external source. In any event, if it be relevant, the evidence is that Orica rejected such an option and there is insufficient evidence to conclude that Orica's directors would have funded OUSSI from external sources. The inquiry called for by s 177D is, rather, what was the dominant purpose of entering into the transactions that Orica did choose. It is an inquiry that must be undertaken by having regard to the eight matters in s 177D(b) and, as a conclusion about purpose to be drawn from those matters, will require an evaluation of inference and degree.
21. The first matter required by s 177D(b) to be considered is "the manner in which the scheme was entered into or carried out". The joint judgment in Spotless Services in the High Court observed at 420 that "manner" and "entered into" are not given any restricted meaning and that "manner" includes "consideration of the way in which and method
ATC 18188or procedure by which the particular scheme in question was established". Orica submitted that the "form or shape" of the transactions in this case "arose from the need to contribute funds to the US Orica group to enable it to earn sufficient US taxable income to justify the rebooking of US tax losses under the applicable accounting standards". Orica submitted that this was done by Orica making loans "with commercial rates of interest and redeemable preference shares" of the kind ordinarily seen in commercial transactions. An aspect of the manner in which the need to contribute funds into the US Orica group was achieved, however, as is clear from the joint expert report, and in particular from the evidence of Mr Stevenson, was that the relevant transaction was structured to have, as an essential element, deductions being obtained by the Orica group in Australia. The decision to utilise the US tax losses, in other words, may "bear the character of a rational commercial decision" but the presence of that "characteristic does not determine the answer to whether, within the meaning of Part IVA, a person entered into or carried out a 'scheme' for the 'dominant purpose' of enabling the taxpayer to obtain a 'tax benefit'": see Spotless Services at 416. The answer to that question will depend upon the identification of that which is productive of the tax benefit and an evaluation of its significance.
22. The criteria for the application of Part IVA will in part be met if the steps taken to achieve Orica's objectives were "in a manner indicating" a result of obtaining a tax benefit: see Spotless Services at 416. The US subsidiary was not in a position to derive sufficient income from ordinary trading in its business to utilise the losses or to rebook them before utilisation. The US subsidiary needed a source of income to utilise the losses and that source needed to be "virtually certain" if the losses were to be rebooked for accounting purposes. Orica may, therefore, be seen as a taxpayer having "a particular objective or requirement which [was] to be met or pursued by what, in general terms, would be called a transaction": see Spotless Services at 416. The critical question for the purposes of the application of s 177D, however, is whether the "shape" or "form" that was adopted to achieve the objective or requirement indicated the presence of a dominant purpose of obtaining the tax benefits occasioned by the deductions arising from the interest incurred by OFL. The method or procedure adopted by Orica to achieve its result does indicate the dominant purpose of obtaining the tax deductions for the interest incurred by OFL. The procedure adopted by Orica to achieve its objective was a wholly intragroup funding arrangement with a deductible interest expense to Orica through OFL which gave rise to the operating profits for the group. The method chosen for the internal funding of the income of the US subsidiary was the creation of wholly intercompany loans upon which OFL incurred interest and the US subsidiary derived income. The source of the money lent by the US subsidiary to OFL was the money which had been lent by OFL to OEH. The interest rates payable were governed by group policy and were not the product of arms-length bargaining. The transaction as a whole, looked at from OFL's position, was not commercial, and was not intended to produce anything but a loss to OFL. OFL's participation is explained by the economic benefit to the group as a whole which had a consolidated after tax benefit equal to the deductions available from the interest paid by OFL. In considering the manner in which the scheme was entered into it is also relevant that the transactions were entered by members of a group of companies wholly controlled by their parent company through those at head office able to direct group policy and to effect its implementation within each of the subsidiaries. The scheme brought no lasting advantage to the group other than from the tax saved by the domestic deductions for the interest, and was wound up when the US losses were no longer available: at that time the economic benefit to the group of the deductions for the interest paid by OFL was no longer sheltered by the benefit of the losses in the US subsidiary.
23. It was submitted for Orica that the tax deductions for the interest incurred by OFL were not the "ruling, prevailing, or most influential purpose" because from an accounting point of view the reported profits were not more attributable to any one of the three accounting components of the transactions as set out in the joint expert report at . Mr Holland had previously expressed the opinion that the deductions for the interest expense were
ATC 18189"the reason for the increase in reported profits of $33.8 million". Mr Stevenson, in contrast, at paragraph 13 of the joint report, said that he was of the view that there was "no accounting perspective" for choosing between the three components of the transactions to determine which of them led to the increase in the reported profits of the Orica group. Mr Stevenson said that he would not attribute the increase in the reported profits to a single component as there was no basis in accounting for choosing between the components either as to cause or primacy. Mr Holland, in the joint report, acknowledged "that the increase in the reported profit of [the] Orica group was caused by a combination of the matters raised by Mr Stevenson" rather than by any individual item alone and accepted that any implication to the contrary in his previous opinion was inadvertent.
24. It may be assumed from this evidence of the experts that the transactions had a favourable impact upon Orica's reported consolidated profits. It may also be assumed, as the experts agreed, that from an accounting perspective, the increase in the reported profits of the Orica group was caused by a combination of (a) the accounting for the deductability of the interest incurred by OFL, (b) the accounting for the assessability of the interest income of OUSSI, and (c) the accounting for the recognition of the "un-booked" benefits of tax losses in OUSSI. The fact, however, that an outcome or result is the necessary consequence of the combined operation of multiple elements does not exclude a conclusion that the result was achieved by a particular form, or in a manner, indicating the presence of a dominant purpose of enabling a taxpayer to obtain a tax benefit. The conclusion called for by s 177D is not arrived at by syllogistic reasoning, or by application of a "but for" test, but depends upon an evaluative judgment. It is a conclusion to be reached by reference, in part, to the manner in which Orica's result was achieved in this case: s 177D(b)(i) of the 1936 Act. The utilisation of the US tax losses by the intra group generation of income would have made little sense without the tax deductions to Orica in Australia. There would have been no point to utilise the losses in the United States by the creation of internally generated income for the US subsidiary without a corresponding benefit to the group: the use of the US tax losses in the US was commercially valuable to the Orica group because its economic effect was enjoyed though the tax deductions in Australia. OUSSI did not put in funds for its commercial activities with third parties but to derive interest income from the group's Australian finance company which could claim tax deductions. The inability to choose as to cause or primacy between the three components which in combination produce an outcome, from an accounting perspective, does not gainsay the conclusion that the dominant purpose for entering into or carrying out the schemes was to obtain the tax benefits which that combination was intended to produce (just as the pursuit of a commercial purpose, or as securing the maximum return on money, is consistent with a conclusion that a scheme was entered into with the dominant purpose of obtaining a tax deduction: see Spotless Services at 415 and 423; see also
Federal Commissioner of Taxation v Citigroup Pty Ltd (2011) 193 FCR 380, 399 ). It may be that the accounting effect was the undisectable combined accounting product of three components but only one explained the actual profit to the group.
25. The second matter required by s 177D(b)(ii) to be considered is the form and substance of the schemes. The form in this case consisted of internal loans from OFL to OEH, the subscription by OEH of redeemable preference shares in OUSSI, a partial repayment of loans by OUSSI to OFL (in the 2002 year of income), and the lending by OUSSI to OFL of funds at interest. The substance of these transactions was a net increase in the reported profits of the group equal to the effect of the tax deductions claimed by OFL for the interest payable to OUSSI. The interest payable to OFL by OEH was offset in the group consolidated accounts by the interest payable by OEH to OFL. OEH's increased shareholding in OUSSI through the redeemable preference shares had no impact on the consolidated accounts or on the tax payable. The effect of the transactions within the group was substantially neutral except to the extent that the rebooking of the US tax losses recorded the use of those losses against the internally generated income derived by OUSSI
ATC 18190equal to the deductions claimed by OFL for Australian tax purposes. A consideration of the form and substance of the schemes in this case points to the obtaining of the tax benefits for Orica (and, if it be relevant, for OFL: see
Channel Pastoral Holdings Pty Ltd v Federal Commissioner of Taxation  FCAFC 57) as the dominant purpose of those who entered into and carried out the schemes. The form of the schemes was a complex series of loans, transfers and share subscriptions but their substance was to create outgoings within the group that were deductible for Australian tax purposes to enable the group to enjoy the economic benefit of the US tax losses by the tax benefits in Australia from the deductions for the interest payments.
26. The third matter required by s 177D(b)(iii) to be considered is the time at which the schemes were entered into and the length of the period during which the schemes were carried out. It is significant that the schemes in question were entered into at, and extended over, a time when OUSSI had some $52 million worth of US tax losses for the group to utilise, rather than, for example, a time when the US group needed to be capitalised for ordinary trading operations. Each scheme was entered into to enjoy the economic benefit of the use of the available US tax losses over time and the schemes were wound up when the US tax losses were fully utilised. OUSSI had fully utilised the available US tax losses by the end of the 2006 financial year and Mr Muculj thereafter sought the necessary approvals for the redemption of the redeemable preference shares which had been issued by OUSSI pursuant to each tranche of the refinancing, and for the repayment of the loan accounts between OUSSI and OFL. OUSSI redeemed the redeemable preference shares on issue to OEH in late August 2006 pursuant to a resolution of the board of OUSSI to redeem the Series B, C and D preference shares made on 24 August 2006. The timing, therefore, also points to obtaining the tax deductions as the dominant purpose of the relevant participants. The schemes operated only for the time that the deductions in Australia gave the Orica group the after tax benefit in its reported profits necessarily arising from the composite transaction by which deductions were claimed in Australia.
27. The fourth matter required by s 177D(b)(iv) to be considered is the result in relation to the operation of the Act that, but for Part IVA, would be achieved by the schemes, which Orica conceded (albeit as the only factor doing so) supported "the conclusion that the claiming of interest deductions was Orica's dominant purpose". This requirement draws attention to how the 1936 Act and the 1997 Act (see the definition of "this Act" in s 6(1) of the 1936 Act) would apply to the schemes if Part IVA did not. The particular importance of this matter is that it provides the reference point by which to see how the schemes in question operated under tax law (without Part IVA) to enable the relevant taxpayer to obtain the relevant tax benefits. In this case the result of the operation of the tax Acts differed in formal operation before and after tax consolidation of the Orica group on 28 August 2003, although the parties did not contend that Orica was not the relevant taxpayer (cf
Channel Pastoral Holdings Pty Ltd v Federal Commissioner of Taxation  FCAFC 57). The position before tax consolidation was that OFL derived assessable income in the form of interest on its loan to OEH which, for its part, OEH was able to claim as a tax deduction. OFL was able to claim deductions for the interest it paid to OUSSI and OUSSI was liable for interest withholding tax which OFL was obliged to withhold. In the 2003 and 2004 US income tax years, however, OUSSI claimed a deduction for the amount of Australian withholding tax which contributed to the balance of its US tax losses in those years. The tax accounting for the group after consolidation on 28 August 2003 required Orica to be treated as the taxable entity as the head company. Orica was able to claim deductions for the interest OFL paid to OUSSI, and, under the first scheme, Orica derived income in the form of a dividend of approximately AUD$64.5 million in the year ended 30 September 2006 which was not subject to tax by reason of s 23AJ of the 1936 Act. OUSSI remained liable for interest withholding tax which Orica was obliged to withhold but was able to claim deductions in the 2003 and 2004 years and a foreign tax credit in the 2005 year. The foreign tax credit claimed in the 2005 year was not utilised in 2005. In the 2006 year a foreign tax credit was claimed for
ATC 18191the Australian withholding tax paid in that year. In the 2006 year the 2003 and 2004 US income tax returns were amended to remove the deductions for the amounts of withholding tax and to claim instead a foreign tax credits for those amounts. The credits were not utilised in those years but were carried forward, and the 2005 US income tax return was amended to record an increase in the total carried forward foreign tax credits arising as a result of the amendments made to the 2003 and 2004 US tax returns. Foreign tax credits of USD$1,206,816 remain unutilised. The net effect of the operation of the tax Acts if Part IVA did not apply was to secure for Orica the economic benefit of the tax deductions for the interest incurred by OFL.
28. The fifth matter required by s 177D(b)(v) to be considered is any change of the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the schemes. A consideration of this matter is not satisfied simply by repeating the elements of the schemes but requires consideration of the change in the financial position of the taxpayer as a result of the schemes. The change in the financial position of Orica resulting from the schemes, as the head company, was a net increase in reported profits referable to the effect of the use of the US tax losses by the US subsidiary and the deductions for the interest payable by OFL. The combined net financial effect of the transactions, as the joint expert report explained, was to increase the reported profits of Orica by the amount of the tax deductions for the interest income used to offset against the US losses. This matter also points to the tax benefits as the dominant purpose.
29. The sixth matter required by s 177D(b)(vi) to be considered is the change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the schemes. This matter focuses consideration upon the financial position of those connected with the taxpayer obtaining the tax benefits in connection with the schemes. The taxpayer in this case was Orica and the other persons contemplated by the provision were assumed by the parties (in my view correctly) to be the subsidiaries which were affected by the schemes. The changes in the financial position of OUSSI resulting from the schemes were: a discharge of a pre-existing interest bearing debt to OFL; an increased net capital for the 2002 to 2005 income years as a result of the subscription for redeemable preference shares made by OEH; the derivation of interest income taxable in the United States during the operation of the schemes; the incurrence of a liability for Australian withholding tax on the amounts of interest credited by OFL to OUSSI; an ability to claim foreign tax credits in the United States in respect of the amount of withholding tax remitted, but which were not utilised before the year ended 30 September 2006 resulting in a cash outgoing to the group not offset by a tax credit contemporaneously utilised; the recognition of the total pre-tax value of the interest income received from OFL in its statement of financial performance because of the existence and utilisation of unbooked US tax losses; and the payment of a dividend to its Australian redeemable preference shareholder in August 2006 in an amount approximately USD$49 million. The financial changes to OUSSI brought about by these transactions were made possible by the schemes which necessarily included the fact that OFL became liable to pay interest which was to be claimed by it as a deduction before consolidation, and which were claimed by Orica as deductions thereafter. The positive change in the financial position for OUSSI was occasioned not by its ordinary business dealings with third parties but by the ability of the group to make use of OUSSI's US tax losses by the creation of loans which gave rise to corresponding tax deductions in Australia. The change in the financial position of OEH resulting from the schemes was relevantly neutral. It obtained redeemable preference shares in its subsidiary which may have increased its capital by the extent of the subscription for those shares, but it did so by borrowings which increased its indebtedness to OFL. The change to the financial position of OFL resulting from the schemes was an obligation to pay interest to the US subsidiary and US withholding tax. OUSSI's change in net financial position included the
ATC 18192repayment of its previous intercompany debt and, more significantly, the use of the US tax losses to offset against its intercompany generated interest income. The change of the other relevant persons was essentially neutral. The net change in the financial position of the relevant persons connected with the taxpayer also points to the obtaining of tax benefits as the dominant purpose.
30. The seventh matter required by s 177D(b)(vii) to be considered is any other consequences for the relevant taxpayer, or any other person connected to the relevant taxpayer, of the schemes having been entered into or carried out. The Commissioner correctly submitted that there were no other consequences for the relevant taxpayer, or for any other person connected with the taxpayer, of the schemes having been entered into or carried out. Orica submitted, in contrast, that it had intended to improve the perceptions of investors in relation to its financial performance through the US refinancing with a view to securing an increase in its share price and that Orica avoided the risk of breaching financial covenants which it had given to its lenders. Mr Malcolm Broomhead, who was the managing director and chief executive officer of Orica from September 2001 to September 2005, gave evidence of concerns that Orica might be susceptible to a takeover and that Orica's financiers might withdraw their support if its financial position continued to worsen. The evidence, however, does not establish a causal link between entering into or carrying out the schemes and any improvement of the perceptions of the investors or of the avoidance of any risk of breaching financial covenants which had been given to Orica's lenders. In any event, any consequence from the schemes to the perceptions of investors or of Orica's financiers would necessarily have arisen from the after tax effect on reported profits for the group arising from the deductions for the interest paid to OUSSI to enable OUSSI to utilise its US tax losses. This factor also points to the tax benefits obtained by Orica as the dominant purpose.
31. The eighth matter required by s 177D(b)(viii) to be considered is the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in sub paragraph (vi). In this regard all companies were connected to the relevant taxpayer in their capacity as members of the same wholly owned group of companies and were controlled from a common source and by the same people. The nature of that connection was one of common control and not of independent commercial or arms length dealings. The nature of such a connection need not always point to the obtaining of a tax benefit as the dominant purpose amongst related entities. Related companies may frequently act for the benefit of the group as a whole, or for the benefit of a related company, without necessitating in all cases that the dominant purpose was for a taxpayer to obtain a tax benefit, but in this case the connection between the parties does point to that as the dominant purpose by showing the role played by that connection as the means by which the schemes were implemented and carried out.
32. Orica submitted that the conclusion to be drawn from a consideration of these matters is that the dominant purpose was not to enable the taxpayer to obtain the tax benefits of the tax deductions for the interest payable to OUSSI. It was submitted in that regard that the ability to claim deductions for the interest payable was "overshadowed by the commercial aspect of the arrangement"; and in particular, "by Orica's immediate and operating purpose - namely to create an income stream that would justify rebooking of its US tax losses, with a consequent increase in reported profits". I do not accept that submission.
33. A conclusion about the dominant purpose of a person who entered into or carried out a scheme is a conclusion of a reasonable person about the "most influential and prevailing or ruling purpose": Spotless Services at 423, see also at 416. In
Mills v Federal Commissioner of Taxation (2012) 250 CLR 171 Gageler J (with whom the other members of the court agreed) said at 202  that "[a] purpose is a consequence intended by a person to result from some action". His Honour was concerned in that case, as his Honour immediately went on to observe, with "a consequence intended by [a] person" in the context of imputation benefits in the application of s 177EA(3)(e), rather than with the application of s 177D, but at 203  his Honour explained that purpose
ATC 18193in the context of s177EA is a matter of inference and incidentally is a matter of degree. In that passage his Honour said:
First, a purpose can be incidental even where it is central to the design of a scheme if that design is directed to the achievement of another purpose. Indeed, the centrality of a purpose to the design of a scheme directed to the achievement of another purpose may be the very thing that gives it a quality of subsidiarity and therefore incidentality. That is not impermissibly to confine the scope of s 177EA(3)(e) to a dominant purpose: the categories of "dominant" and "incidental" are not exhaustive. The parenthesised words in s 177EA(3)(e) make clear that a dominant purpose of enabling a holder to obtain a franking credit is sufficient but not necessary for the requisite jurisdictional fact to exist, but it does not follow that a purpose which does no more than further or follow from some dominant purpose is incidental. Secondly, counterfactual analysis is not antithetical to the statutory inquiry mandated by s 177EA(3)(e). Purpose is a matter for inference and incidentality is a matter of degree. Consideration of possible alternatives may well assist the drawing of a conclusion in a particular case that a purpose of enabling a holder to obtain a franking credit does or does not exist and, if such a purpose exists, that the purpose is or is not incidental to some other purpose.
The conclusion of dominant purpose called for by s 177D is also a matter of degree in the sense explained in Spotless Services. At 416 in the joint judgment in Spotless Services their Honours said:
Much turns upon the identification, among various purposes, of that which is "dominant". In its ordinary meaning, dominant indicates that purpose which was the ruling, prevailing, or most influential purpose. In the present case, if the taxpayers took steps which maximised their after-tax return and they did so in a manner indicating the presence of the "dominant purpose" to obtain a "tax benefit", then the criteria which were to be met before the Commissioner might make determinations under s 177F were satisfied. That is, those criteria would be met if the dominant purpose was to achieve a result whereby there was not included in the assessable income an amount that might reasonably be expected to have been included if the scheme was not entered into or carried out.
In the joint judgment in Spotless Services it was said about the scheme considered in that case at 423:
The scheme was the particular means adopted by the taxpayers to obtain the maximum return on the money invested after payment of all applicable costs, including tax. The dominant purpose in the adoption of the particular scheme was the obtaining of a tax benefit ... [I]t was the obtaining of the tax benefit which directed the taxpayers in taking steps they otherwise would not have taken by entering into the scheme.
The tax benefit was obtained by the interest payable upon the loan from OUSSI to OFL. That, for the reasons above, was "the ruling, prevailing, or most influential" purpose which overshadowed any other purpose which the schemes may have had. The utilisation of the US tax losses by Orica in this case, and their re-recognition, required the creation of a virtually certain source of income. The losses had been incurred in the US but would remain unutilised unless and until the economic benefit of the US tax losses could be enjoyed by the group by the US company deriving taxable profits. It was clear at the time that the US operations could not take advantage of the US losses by normal operation of the US business. Circumstances could be created for the US subsidiary to derive income to offset against the US tax losses but the use of the US tax losses would be of no economic benefit to the group unless the US losses had the effect of reducing the tax otherwise payable by the group on income which could not otherwise be sheltered by the US tax losses. Three components to the accounting entries effected the increase in Orica's reported profits: (a) those related to the derivation by OUSSI of interest income which increased Orica's consolidated income tax expense, (b) those related to the bringing to account of unbooked US tax losses which reduced Orica's
ATC 18194consolidated income tax expense by the same amount as it had been increased by the previously mentioned entry, and (c) those related to the claiming by Orica of the deductions for the interest incurred by OFL to OUSSI. It may readily be accepted that the increase in the reported profits arose from the combination of these three accounting entries, but from an accounting point of view, and as a reflection of reality, the first two necessarily neutralised each other leaving the effect of the third as the quantum of the increase in the reported profits. The rebooking of the tax losses did not, and could not, increase the reported profits of the Orica group. The increase in the reported profits depended upon the allowability of the deductions claimed for the interest incurred by OFL: see Spotless Services at 423; Hart at 228 , 244 , 262 ;
Federal Commissioner of Taxation v Citigroup Pty Ltd (2011) 193 FCR 380, 399 .
34. Orica also contended that the tax benefit occasioned by the deductions could not be the dominant purpose because the more immediate benefit was the utilisation of the US losses by OUSSI and, in any event, that the Australian group had other losses which could have been transferred within the group. The fact that Orica might have been able to utilise other losses, and that, therefore, the group may not have had a "cash saving" from the schemes is irrelevant to the inquiry called for by s 177D. It is also irrelevant to that inquiry that Orica might not have enjoyed the consequential benefit of a reduction in tax payable in the same year in which a tax deduction is obtained. A tax benefit in the form of a deduction is not the same as the foreign tax credit considered by Hill J in
CPH Property Pty Ltd v Federal Commissioner of Taxation (1998) 88 FCR 21, 42. The deductions in this case were for interest incurred upon loans and, as such, were obtained as deductions (and therefore as tax benefits) upon their incurrence and not subsequently upon the calculation of tax payable upon taxable income. The deductions were, therefore, sought and were obtained immediately as they were incurred and were available to the Orica group. It is not to the point that OFL may have had other tax losses, or that it had no taxable income, in the 2002 income year or in the subsequent income year to 27 August 2003. In each case the deductions were claimed and were available for immediate use as and when the interest was incurred. Furthermore, if it be relevant, the losses returned by OFL for the 2002 and 2003 years were subsequently amended, and OFL subsequently showed taxable income in each period of $6,459,499 and $22,851,200 respectively. Orica's appeals against the Commissioner's application of Part IVA will accordingly be rejected.
35. It is next necessary to consider the administrative penalties imposed under s 284-145(1). The Commissioner has also assessed Orica to scheme shortfall penalties for the years ended 30 September 2004 to 2006 under s 284-145(1) of Schedule 1 to the Administration Act on the basis that it obtained a scheme benefit in each of those years. Orica submitted that no penalties were payable pursuant to s 284-145(1) because it was not reasonable to conclude that Orica (or OFL, OEH and OUSSI) entered into the schemes for the sole or dominant purpose of obtaining the scheme benefits. Section 284-145(1) relevantly provided:
284-145 Liability to penalty
(1) You are liable to an administrative penalty if:
- (a) you would, apart from a provision of a taxation law or action taken under such a provision (the adjustment provision ), get a scheme benefit from a scheme; and
- (b) having regard to any relevant matters, it is reasonable to conclude that:
- (i) an entity that (alone or with others) entered into or carried out the scheme, or part of it, did so with the sole or dominant purpose of that entity or another entity getting a scheme benefit from the scheme; or
(3) It does not matter whether the scheme, or any part of the scheme, was entered into or carried out inside or outside Australia.
Orica's liability to administrative penalties under this provision depends upon whether it is reasonable to conclude that the schemes were entered into with the sole or dominant purpose of getting scheme benefits from the schemes. In that context a question has arisen in other cases about whether the inquiry occasioned
ATC 18195by the provision calls for a finding of the actual or subjective purpose of the relevant entity rather than of the objective purpose. In
Lawrence v Federal Commissioner of Taxation (2008) 70 ATR 376 Jessup J at 407  accepted a submission by counsel that the provision "requires consideration of subjective, rather than of objective, purpose" but went on to say that it was "a normal and legitimate part of the fact-finding process to infer what was a person's subjective purpose from circumstances confronting him or her, and from things done by, and statements made by, him or her, in response to those circumstances": see also
Mills v Federal Commissioner of Taxation (2012) 250 CLR 171, 202 , 203 . Subsequently, in
Federal Commissioner of Taxation v Star City Pty Ltd (No 2) (2009) 180 FCR 448, Dowsett J observed that Jessup J had appeared to have accepted in Lawrence, but without deciding, an erroneous submission by counsel, namely, that the earlier decision in
Federal Commissioner of Taxation v Starr (2007) 164 FCR 436 was authority for the proposition that purpose under s 284-145(1) was to be subjectively determined. In Star City (No 2) Dowsett J went on to say that his Honour, in contrast, was inclined to the view that the question posed by the section was "whether a reasonable person could conclude that the relevant entity had the identified purpose" rather than that the section called for an actual decision as to purpose.
36. The question in the context of these provisions was also considered recently by Robertson J in
Chevron Australia Holdings Pty Ltd v Commissioner of Taxation (No 4)  FCA 1092, which was decided after the hearing in this proceeding, but to which the Commissioner subsequently drew attention by a note to chambers with notice to Orica. In that case his Honour said at :
I add that, contrary to the respondent's submission set out at  above, I do not regard Star City Pty Ltd (No 2) as standing for the proposition that the relevant approach is that a reasonable person could conclude that each of CAHPL, CFC and CVX had the relevant dominant purpose: compare Star City Pty Ltd (No 2) at  per Dowsett J. I prefer directly to apply the statutory language, which raises the issue whether it is reasonable to conclude that an entity that (alone or with others) entered into or carried out the scheme, or part of it, did so with the sole or dominant purpose of that entity or another entity getting a scheme benefit from the scheme. By reason of that statutory language, I do not accept that the question is solely subjective but I do accept that the purpose of the entity is its subjective purpose: see Star City Pty Ltd (No 2) at - per Goldberg and Jessup JJ and Ludekens at  which I have set out at  above. [Emphasis in original]
In my view the differences between the passages to which I have referred may be less significant than they may at first appear. Dowsett J expressed the view that the question posed by the section addresses the availability of an inference, but it is clear from the passage quoted above from Lawrence that Jessup J also considered it appropriate in the process of fact finding to infer what a person's subjective purpose was from relevant evidence. In each case their Honours, including Robertson J in Chevron, considered it appropriate to make a finding about subjective purpose based, where relevant, upon inferences. In each case the relevant finding was one about the actual (that is, the subjective) purpose that the relevant person had. Robertson J in Chevron at  specifically identified the purpose as the "subjective purpose" of the relevant entity. Dowsett J in Star City (No 2) similarly spoke at  of a conclusion that the relevant entity "had the identified purpose". In each case the purpose that needed to be found was an actual purpose of an entity (that is, of its subjective purpose) upon the evidence that bore probatively upon that fact, and may be contrasted with the statutory purpose attributed to a person irrespective of the actual purpose which the relevant person may have had: cf
Federal Commissioner of Taxation v Consolidated Press Holdings Limited (2001) 207 CLR 235, 264 ;
Federal Commissioner of Taxation v Hart (2004) 217 CLR 216, 222 , 227 , 243 ; see also
Mills v Federal Commissioner of Taxation (2012) 250 CLR 171, 202 , 203 , 206 -. The use of the words "it is reasonable to conclude" in s 284-145(1)(b) is thus not to be seen to impose a
ATC 18196test of objective purpose in place of a finding of the actual (subjective) purpose which the relevant person had (cf Star City (No 2) at -) but to qualify the factual finding of an actual purpose in an important respect, namely, that it will be sufficient for the subjective purpose to be found as a reasonable inference rather than requiring a higher threshold: it will be sufficient, in other words, to find an actual purpose if it can reasonably be concluded from the evidence.
37. In this case a reasonable person would conclude that the relevant entity entered into or carried out the schemes with the dominant purpose of the taxpayer (whether that be Orica or OFL) getting scheme benefits from the schemes. It may be accepted that the motivation of the people concerned was to utilise the US tax losses by rebooking of the losses through an arrangement which provided virtual certainty of the American subsidiary being able to utilise the tax losses, but their motivation was achieved by schemes with their dominant purpose of the taxpayer getting scheme benefits. The scheme benefit was the dominant purpose because without it the schemes made no sense. The relevant entities, through Mr Muculj in particular, entered into the transactions only to generate accounting profits which impacted the group's net profit through the tax deductions which the schemes were necessarily contemplated, and designed, to obtain. The evidence of Mr Muculj and Mr Collins explaining the schemes in terms of increasing US income and rebooking US tax losses must be taken into account with all of the evidence including that as experienced tax advisers they had knowledge of the transactions and of their economic effects, and that they knew and intended to produce the economic outcome which depended upon the taxpayer getting scheme benefits. Mr Muculj, and through him both OFL and Orica, knew that the impact of the transactions on the accounting profits would occur through the tax expense item. Mr Muculj knew that the transactions included the generation of deductions in Australia and that the increase in the reported profits would be the same as the Australian tax affected by the deductions. The taxpayer, through Mr Muculj, knew and intended that at the time the schemes were entered into no more than the amount of losses needed to neutralise the increase in the tax expense caused by the interest income would be recognised in each year. Mr Muculj knew that Orica's external auditors would not find it acceptable to rebook more than two years of the US tax losses in light of the continued poor performance of the US business and the fact that the full write down of the losses had only occurred the previous year. The evidence of the joint expert report makes clear, as was the evidence of Mr Muculj, that the reduction in the income tax expense caused by the recognition of the income tax deductions was critical to the outcome sought to be achieved. In the circumstances it is reasonable to conclude that those who entered into these schemes did so with the dominant purpose of Orica, and before it OFL, getting scheme benefits from the schemes.
38. The final question to consider is whether the appropriate penalty amount should be 25% of the scheme shortfall amounts because the position argued for by Orica that Part IVA did not apply was reasonably arguable for the purposes of s 284-160(1) of Schedule 1 to the Administration Act. Section 284-155 provides that the base penalty amount payable is to be worked out under s 284-160 which, in turn, by s 284 160(1)(b), provides that the base penalty amount is 25% of the scheme shortfall if it is "reasonably arguable" that the relevant adjustment provision, in this case Part IVA, does not apply.
39. Section 284-15 is concerned with when a matter is reasonably arguable. The relevant text of the section relied upon by the parties provides:
284-15 When a matter is reasonably arguable
(1) A matter is reasonably arguable if it would be concluded in the circumstances, having regard to relevant authorities, that what is argued for is about as likely to be correct as incorrect, or is more likely to be correct than incorrect.
(2) To the extent that a matter involves an assumption about the way in which the Commissioner will exercise a discretion, the matter is only reasonably arguable if, had the Commissioner exercised the discretion
ATC 18197in the way assumed, a court would be about as likely as not to decide that the exercise of the discretion was in accordance with law.
(3) Without limiting subsection (1), these authorities are relevant:
- (a) a taxation law;
- (b) material for the purposes of subsection 15AB(1) of the Acts Interpretation Act 1901;
- (c) a decision of a court (whether or not an Australian court), the AAT or a Board of Review;
- (d) a public ruling.
The text of the provision in these terms was introduced with effect from 2005 by the Tax Laws Amendment (Improvements to Self Assessment) Act (No 1) 2005 (Cth) which inserted the word "about" after the words "argued for", but nothing would appear to turn upon that amendment (see also Explanatory Memorandum to the Tax Laws Amendment (Improvements to Self Assessment) Bill (No 1) 2005 at 3.12 and 3.13) and no submission was made by either party that the relevant provisions were other than as quoted above or to a different effect.
40. Provisions to broadly the same effect as those now found in s 284-15 were previously found in s 222C and 226K of the 1936 Act. Section 226K of the 1936 Act imposed a penalty by reference, in part, to whether a taxation statement by a taxpayer treating an income tax law as applying in a particular way was not "reasonably arguable" when the statement was made. Section 222C(1), however, supplied a specific meaning to the words "reasonably arguable", namely:
(1) For the purposes of this Part:
- (a) the correctness of the treatment of the application of a law...
is reasonably arguable if, having regard to the relevant authorities and the matter in relation to which the law is applied ... it would be concluded that what is argued for is about as likely as not correct.
Section 284-15 is in broadly similar, but different, terms. Section 284-15(1) substituted the words "that what is argued for is [about] as likely to be correct as incorrect, or is more likely to be correct than incorrect" for the test in s 222C(1), namely, "that what is argued for is about as likely as not correct". Both statutory tests applied to the meaning of the words "reasonably arguable" which were not left to have their ordinary meaning, although, of course, the ordinary meaning of those words might inform the conclusion reached about whether an argument was, at least, "as likely to be correct than incorrect".
41. Hill J considered the correct approach to the application of s 226K in the context of s 222C(1) in
Walstern v Commissioner of Taxation (2003) 138 FCR 1 and said at 26-7 :
- 1. The test to be applied is objective, not subjective. This is clear from the use of the words "it would be concluded" in para(1)(b) of the section;
- 2. The decision-maker considering the penalty must first determine what the argument is which supports the taxpayer's claim;
- 3. That person will already have formed the view that the claim is wrong, otherwise the issue of penalty could not have arisen. Hence the decision-maker at this point will need to compare the taxpayer's argument with the argument which is considered to be the correct argument;
- 4. The decision-maker must then determine whether the taxpayer's argument, although considered wrong, is about as likely as not correct, when regard is had to "the authorities";
- 5. It is not necessary that the decision-maker form the view that the taxpayer's argument in an objective sense is more likely to be right than wrong. That this is so follows from the fact that tax has already been short paid, that is to say the premise against which the question is raised for decision is that the taxpayer's argument has already been found to be wrong. Nor can it be necessary that the decision-maker form the view that it is just as likely that the taxpayer's argument is correct as the argument which the decision-maker considers to be the correct argument for the decision-maker has already formed the view that the taxpayer's argument is wrong. The standard is not as high as that. The word "about"
ATC 18198indicates the need for balancing the two arguments, with the consequence that there must be room for it to be argued which of the two positions is correct so that on balance the taxpayer's argument can objectively be said to be one that while wrong could be argued on rational grounds to be right;
- 6. An argument could not be as likely as not correct if there is a failure on the part of the taxpayer to take reasonable care. Hence the argument must clearly be one where, in making it, the taxpayer has exercised reasonable care. However, mere reasonable care will not be enough for the argument of the taxpayer must be such as, objectively, to be "about as likely as not correct" when regard is to be had to the material constituting "the authorities"; and
- 7. Subject to what has been said the view advanced by the taxpayer must be one where objectively it would be concluded that having regard to the material included within the definition of "authority" a reasoned argument can be made which argument when contrasted with the argument which is accepted as correct is about as likely as not correct. That is to say the two arguments, namely, that which is advanced by the taxpayer and that which reflects the correct view will be finely balanced. The case must thus be one where reasonable minds could differ as to which view, that of the taxpayer or that ultimately adopted by the Commissioner was correct. There must, in other words, be room for a real and rational difference of opinion between the two views such that while the taxpayer's view is ultimately seen to be wrong it is nevertheless "about" as likely to be correct as the correct view. A question of judgment is involved.
That approach was adopted by the Full Court in
Pridecraft Pty Ltd v Federal Commissioner of Taxation (2004) 213 ALR 450, . The Full Court in
Allen v Federal Commissioner of Taxation (2011) 195 FCR 416 at 436 , however, expressed the view that Stone and Allsop JJ (as the Chief Justice then was) had taken a "somewhat less strict" approach of whether a question was "open to debate in the sense of being arguable" in
Cameron Brae Pty Ltd v Federal Commissioner of Taxation (2007) 161 FCR 468 at : see also
Sent v Federal Commissioner of Taxation (2012) 85 ATR 1, 44-45 .
42. In Cameron Brae Stone and Allsop JJ (as the Chief Justice then was) had considered s 226K in the context of what Hill J had said in Walstern, and in Cameron Brae their Honours said at 488 :
In our view, the question of construction and interpretation of s 82AAE was reasonably open and arguable. No authority squarely covered it. The proper interpretation depended upon the construction of s 82AAE informed by a full appreciation of the statutory history. The argument about the applicability or satisfaction of s 82AAE was arguable. That question can be seen as subsuming s 8-1, if it were answered one way. If it be necessary to decide, we are also prepared to conclude that the issue as to the characterisation of the outgoing as capital or revenue was arguable. Whilst in our view it is clear that it was a payment of a capital nature, the question is open to debate in the sense of being arguable.
The issue in Cameron Brae concerned the proper construction of s 82AAE of the 1936 Act and their Honours found that a construction of s 82AAE was reasonably arguable but in doing so, and without reference to the effect of s 222C(1) upon s 226K, did not express themselves as departing from the approach enunciated by Hill J in Walstern which had been adopted by the Full Court in Pridecraft.
43. It was submitted on behalf of Orica that its position that Part IVA did not apply was reasonably arguable because "it can be argued on rational grounds that Part IVA does not apply to the scheme in question". This submission, however, does not take into account the test in s 284-15(1) that requires a conclusion that "what is argued for is about as likely to be correct as incorrect, or is more likely to be correct than incorrect". Those words informed the approach taken by Hill J in Walstern because his Honour had regard to the provision of s 222C(1) of the 1936 Act as applied to s 226K. Stone and Allsop JJ (as the Chief Justice then was) in Cameron Brae did not purport to adopt a different test from that
ATC 18199which had been enunciated by Hill J in Walstern and which had been adopted by the Full Court in Pridecraft. Nor did their Honours in Cameron Brae expressly consider s 222C when expressing their conclusion about whether a construction of a provision, namely s 82AAE of the 1936 Act, was arguable. The decision of the Full Court in Allen, like that in Cameron Brae, and in contrast to that in Walstern, turned on a question of statutory construction which was free from statutory authority squarely covering the point: see at 436  and . In Allen, as in the joint judgment in Cameron Brae, the Court did not consider the impact upon the proper approach to s 226K of the 1936 Act of s 222C. In the present case the matter argued for was not free from authority.
44. The matter argued for by Orica is different from that in Cameron Brae and Allen. The Full Court distinguished Walstern on the basis that the issue in Cameron Brae and Allen turned "on questions of statutory construction". In Allen the Court said at 436 -:
- 77 The present case, like Cameron Brae, and in contrast to Walstern, turns on questions of statutory construction. Walstern was a case where the erroneous position advanced in a taxpayer's return was founded upon an unreasonable view of, or a disregard for, the facts. See Walstern at .
- 78 In this case, as in Cameron Brae, the questions of statutory construction on which the case turns were free from authority squarely covering the point. And as our reasons on the substantive issues show, the taxpayers' position was debatable. There is another consideration which is relevant here.
The matter argued for by Orica turns, not upon disputed construction of statutory provisions on which there is no authority or conflicting authority, but upon the application of s 177D to the facts where there was established authority concerning the construction and application of the section. I am not persuaded that the position argued for was reasonably arguable within the relevant statutory meaning. Section 284-15(1) requires that regard be had to relevant authorities to determine whether it would be concluded that what Orica argued for was "about as likely to be correct as incorrect, or [was] more likely to be correct than incorrect". The time for testing whether Orica had a reasonably arguable position is the time at which the scheme was entered into or carried out. Orica submitted that the relevant time in this case was 31 May 2002. At that time Spotless Services and Consolidated Press Holdings had been decided and were relevantly authorities within the meaning of s 284-15(1). I do not consider the position argued for by Orica, namely that Part IVA did not apply, was reasonably arguable as at 31 May 2002 in light of the authorities contemplated by s 284-15(1). The authorities within the meaning of s 284-15(1) had established that the application of Part IVA depended upon its terms by reference to objective criteria. It had been established by Spotless Services that a transaction bearing the character of a rational commercial decision would not "determine the answer to the question whether, within the meaning of Part IVA, a person entered into or carried out a 'scheme' for the 'dominant purpose' of enabling the taxpayer to obtain a 'tax benefit'": Spotless Services at 416; see also Consolidated Press Holdings at 264  and . It had been held in that context that a conclusion about the dominant purpose was one about which was "the ruling, prevailing, or most influential purpose": Spotless Services at 416. In Spotless Services the joint judgment had explained that a reasonable person would conclude that the dominant purpose was obtaining the tax benefit in circumstances where the scheme had been "the particular means adopted" to obtain the maximum return on the money invested after payment of all applicable costs including tax: see 423. Orica did not rely upon any authorities relevant at the time for testing in support of its submission that the position it argued for was reasonably arguable within the meaning of the section.
45. Orica did submit, however, that on 31 May 2002 the High Court had not yet decided the case in Hart. It is true that Hart had not been decided by that date but Spotless Services had been decided, and no submissions were made by either party on how the decision in Hart relevantly affected a conclusion based upon the other authorities at that time about whether the non-application of Part IVA was or was not reasonably arguable either before or
ATC 18200after the date of that decision. There were, in any event, three schemes, and Orica made no submission contrary to that made by the Commissioner to the effect that the relevant times to consider whether or not it had a reasonably arguable position were at each of the dates upon which the schemes were entered into, namely, 31 May 2002, 30 October 2003 and 15 July 2004 respectively. On that view it would seem to follow from Orica's argument, perhaps unintentionally, that the decision of the High Court in Hart was both relevant and adverse to a conclusion about Orica having a reasonably arguable position in respect of the third scheme.
46. It was also contended for Orica that it had not been suggested, nor could be suggested, that it had failed to take reasonable care. In that regard Orica relied upon having sought advice and assistance from a major international accounting firm including its two leading tax partners. However, the question about whether the position taken by Orica was reasonably arguable is to be determined objectively and not by reference to whether the relevant taxpayer took reasonable care: Walstern at ;
Sent v Federal Commissioner of Taxation (2012) 85 ATR 1, 45 . Furthermore, to the extent that reasonable care may be relevant, it is significant that none of the evidence relied upon for Orica on this question concerned any advice about the application of Part IVA: cf Walstern at .
47. Accordingly the appeals will be dismissed.
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