The impact of this case on ATO policy is discussed in Decision Impact Statement: Federal Commissioner of Taxation v Citigroup Pty Ltd (NSD 1016/1117 of 2010).

FC of T v CITIGROUP PTY LTD

Judges:
Stone J
Jessup J
Perram J

Court:
Full Federal Court, Sydney

MEDIA NEUTRAL CITATION: [2011] FCAFC 61

Judgment date: 10 May 2011

Stone, Jessup and Perram JJ

1. There are two appeals presently before the Full Court, each against judgments given by a single Judge of the Court on 9 August 2010. Those judgments arose out of six proceedings before his Honour, each commenced by Citigroup Pty Ltd ("CPL"). Three of these proceedings related to CPL's tax liability in the year ended 31 December 2003 (in lieu of 30 June 2004) ("the 2003 year"), and three related to CPL's tax liability in the year ended 31 December 2004 (in lieu of 30 June 2005) ("the 2004 year"). Of the first group of three -

• the first was an appeal under s 14ZZ of the Taxation Administration Act 1953 (Cth) ("the Administration Act") against the disallowance by the Commissioner of Taxation ("the Commissioner") of an objection lodged by CPL against a Notice of Amended Determination pursuant to s 160AI and 160AK of the Income Tax Assessment Act 1936 (Cth) ("the 1936 Act") in respect of the 2003 year;
• the second was an appeal under s 14ZZ of the Administration Act against the disallowance by the Commissioner of an objection lodged by CPL against a Notice of Assessment and Liability to Pay Penalty in respect of the 2003 year; and
• the third was an application under s 39B of the Judiciary Act 1903 (Cth) claiming declarations that CPL was not liable to pay the general interest charge under s 204(3) of the 1936 Act on the difference between the amount applied by CPL (by way of self-assessment) as foreign tax credits in the 2003 year and the amount determined by the Commissioner in his determination the subject of the first proceeding referred to above.

The primary Judge dismissed CPL's applications in the first and second proceedings referred to, and made the declarations sought by CPL in the third proceeding. CPL now appeals against his Honour's judgments in the first and second proceedings, and the Commissioner appeals against that in the third. The second group of three proceedings - that which related to the 2004 year - corresponded closely with the first, corresponding judgments were given by the primary Judge, and corresponding appeals have been lodged. It was common ground that we might resolve the questions of substance which arise on the appeals by reference to the 2003 year, and that our conclusions would apply equally to the 2004 year.

The nature of the question which arose under Pt IVA

2. In its return lodged in July 2004 with respect to the 2003 year, CPL claimed a foreign tax credit in the amount of $12,421,815. That sum included $11,561,339, being the Australian dollar equivalent of tax paid in Hong Kong in the 2003 year by a partnership in which CPL and another member of the same group were members. That return gave rise to a deemed determination by the Commissioner under s 160AJA of the 1936 Act that a credit, in the sum claimed, was allowable. On 27 June 2008, the Commissioner determined, under s 177F(1)(d) of the 1936 Act, that so much of the foreign tax credit claimed by CPL in respect of the 2003 year as was made up of the sum of $11,561,339 not be allowable. At the same time, the Commissioner, acting pursuant to s 160AI and 160AK of the 1936 Act, determined that the credit claimed by CPL was pro tanto not allowable, and amended the deemed s 160AJA determination to reflect the disallowance. It was those determinations which gave rise to the first of the proceedings which related to the 2003 year to which we have referred in the previous paragraph.

3. The substantial question which arose in that proceeding was whether the Commissioner was justified in making his determination under s 177F(1)(d) of the 1936 Act. Relevantly, that provision was as follows:

"Where a tax benefit has been obtained, or would but for this section be obtained, by a taxpayer in connection with a scheme to which this Part applies, the Commissioner may:

….

(d) in the case of a tax benefit that is referable to a foreign tax credit, or a part of a foreign tax credit, being allowable to the taxpayer - determine that the whole or a part of the foreign tax credit, or the part of the foreign tax credit, as the case may be, is not to be allowable to the taxpayer …."

"By s 177C(1) of the 1936 Act -

(1) Subject to this section, a reference in this Part to the obtaining by a taxpayer of a tax benefit in connection with a scheme shall be read as a reference to:
- …
- (bb) a foreign tax credit being allowable to the taxpayer where the whole or a part of that foreign tax credit would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer if the scheme had not been entered into or carried out;
  and, for the purposes of this Part, the amount of the tax benefit shall be taken to be:
- …
- (f) in a case where paragraph (bb) applies - the amount of the whole of the foreign tax credit or of the part of the foreign tax credit, as the case may be, referred to in that paragraph."

4. At the relevant time, the provisions of Div 18 of Pt III of the 1936 Act dealt with the subject "Credits in respect of foreign tax". Section 160AF(1) provided:

"If:

(a) the assessable income of a year of income of a resident taxpayer includes:

(i) income that is foreign income;

…
and

(b) the taxpayer has paid foreign tax in respect of that income, profit or gain; and

(c) the taxpayer was personally liable for that tax;

the taxpayer is, subject to this Act, entitled to a credit of:

(d) the amount of that foreign tax, reduced in accordance with any relief available to the taxpayer under the law relating to that tax; or

(e) the amount of Australian tax payable in respect of that income, profit or gain;

whichever is the less."

5. The case was conducted on the basis that, but for the Commissioner's action under s 177F(1)(d) itself, a foreign tax credit arose under s 160AF which was a tax benefit obtained by CPL within the meaning of this provision. Indeed, that was the premise by reference to which s 177C(1)(bb) applied to the facts of the present case, and upon which the Commissioner's determination under s 177F depended. It was also common ground that the series of transactions out of which the credit was said to have arisen was a scheme within the meaning of the relevant provisions.

6. What was controversial was whether the scheme was one "to which [Pt IVA] applies" within the meaning of the opening words of s 177F(1). That question called up the operation of s 177D of the 1936 Act, and specifically of para (b) thereof. Relevantly, s 177D provided as follows:

"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:

….

(b) having regard to:

(i) the manner in which the scheme was entered into or carried out;

(ii) the form and substance of the scheme;

(iii) the time at which the scheme was entered into and the length of the period during which the scheme was carried out;

(iv) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme;

(v) any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme;

(vi) any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme;

(vii) any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out; and

(viii) the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (vi);
it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for the purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme or of enabling the relevant taxpayer and another taxpayer or other taxpayers each to obtain a tax benefit in connection with the scheme (whether or not that person who entered into or carried out the scheme or any part of the scheme is the relevant taxpayer or is the other taxpayer or one of the other taxpayers)."

The question was whether, having regard to those of the numbered subparagraphs in para (b) as were relevant in the circumstances, it would be concluded that CPL entered into or carried out the scheme for the purpose of enabling it to obtain the benefit referred to. By s 177A(5), if CPL had two or more purposes for entering into or carrying out the scheme, it was the "dominant purpose" which mattered in the context of s 177D(b). The primary Judge agreed with the Commissioner that CPL's dominant purpose in entering into, and carrying out, the scheme was to obtain the foreign tax credit. CPL contends on appeal that his Honour was in error to have reached that conclusion.

The facts in outline

7. The scheme upon which the Commissioner based his s 177F determination in the present case involved a series of transactions undertaken in Hong Kong on the last day of the 2003 year, 31 December 2003 ("the December transactions"). At the core of those transactions was the purchase by an entity controlled by the Bank of China ("BoC") of the entitlement to interest payments under a bond held by an entity controlled by CPL. It seems that BoC had undertaken such transactions in the past, but that the December transactions were the first in which CPL participated. A significant benefit of such transactions for BoC was, subject to a favourable ruling by the Hong Kong Internal Revenue Department ("HK Internal Revenue"), the obtaining of an immediate tax deduction equal to the purchase price of the interest rights. However, the whole of the purchase moneys were assessable as profits in the hands of the vendor entity. No doubt to secure the integrity of this system, HK Inland Revenue imposed firm guidelines as to how such a transaction should be structured. An aspect of the guidelines was that the vendor entity in a transaction of the kind contemplated be a special-purpose taxable company or partnership which did not otherwise carry on business in Hong Kong.

8. The entity through which CPL participated in the December transactions was BPP (Hong Kong) Partnership ("BPP"), a partnership in which CPL and one of its wholly owned subsidiaries were members. BoC participated by way of CPP (Jersey) Limited Partnership ("CPP"), a partnership in which BoC and Citibank Ireland Financial Services plc were members. The respective interests of the two second-mentioned companies in those partnerships were minuscule: the case was conducted on the basis that, for presently relevant purposes, BPP could be equated with CPL and CPP could be equated with BoC. Indeed, by s 6AB(3)(a)(iii) of the 1936 Act, CPL was deemed to have paid the foreign tax that was, in Hong Kong, the liability of BPP.

9. In his reasons of 9 August 2010, the primary Judge described the steps that were taken by the various parties on 31 December 2003. It is not necessary to refer here to all of them. They commenced with a loan of $169,504,704 from CPL to BPP, sourced from general funds. CPL also made available to BPP a draw-down facility in the amount of $US44,935,906 ($60,495,296). Using these funds, BPP purchased a 5-year $230m bond from Healthcote Limited ("Healthcote"), a Hong Kong company of which the ultimate parent was Citigroup Inc. The bond had two components: (1) Healthcote's promise to pay $230m in five years, and (2) Healthcote's promise to make ten payments of interest, calculated on $230m, at six-monthly intervals. The first payment of interest, due on 2 July 2004, was in the amount of $500,000 (an interest rate of 0.58533% pa) and each of the succeeding nine payments was in the amount of $5,387,400 (a interest rate of 6.30681% pa).

10. BPP then sold the interest rights under the bond - or interest "coupons" as they were described - to CPP for the price of $US50.4m ($67,851,507). That was the aspect which we have earlier described as lying at the core of the December transactions. Of the sale proceeds received from CPP for the coupons, $US3m ($4,038,772) was a "fee" payable to BPP. Thus, using Australian currency for the sake of clarity, the break-up of those proceeds may be represented as follows:

Paid by CPP	$67,851,507
Original investment by BPP	$60,495,296
Fee	$4,038,772
Balance	$3,317,439

The "balance" was described as a "premium" on the sale of the coupons. Both the fee and the premium were distributed by BPP to CPL.

11. The sale of the interest coupons left BPP holding the bond, but without any entitlement to interest. The bond stub, as his Honour described it, was then assigned by BPP to CPL by way of repayment of the original loan of $169,504,704. That was the market price of the stub because the present value of the interest coupons was $60,495,296 and, stripped of that value, the bond stub was now worth exactly what BPP had borrowed from CPL (ie $230m − $60,495,296 = $169,504,704). Probably because most things happened on one day, BPP did not need to avail itself of the draw-down facility of $US44,935,906. It funded that component of the moneys paid to Healthcote for the bond from the $US50.4m it received from CPP for the interest coupons. There were also transaction expenses of $862,699 incurred by CPL, but we do not understand them to be presently controversial.

12. As the assignee of the bond stub, CPL also entered into what was described as an interest rate swap arrangement with the Sydney branch of Citibank NA, a USA company of which the ultimate parent was Citigroup Inc, whereby CPL promised to pay to Citibank NA the sum of $60,495,296 (the difference between the face value of the bond ($230m) and its present value ($169,504,704)) on 31 December 2008 (the date of maturity of the bond) in return for quarterly interest payments by Citibank NA to CPL at the bank bill swap rate, calculated on $169,504,704. As was submitted by counsel for CPL on the appeal, this transaction represented CPL transferring its right to a known sum after 5 years for the right to receive periodical interest payments which depended on market interest rates from time to time.

13. Turning to the tax situation, in Hong Kong, CPL (on behalf of BPP) paid profits tax at the rate of 17.5% on the whole of the proceeds of the sale of the coupons to CPP. That payment was the equivalent of $11,561,339. The Australian tax situation was considerably more complex, and we shall return to it. It is sufficient for present purposes to note that CPL returned, as assessable income in the 2003 year, the fee of $US3m ($4,038,772) and the premium of $US2,464,049 ($3,317,439). CPL treated the gain it stood to make on its underlying investment in the bond stub under the provisions of Div 16E of Pt III of the 1936 Act, such that it was deemed to have received no income in the 2003 year and $12,099,059 in each of the five succeeding years. Those instalments were, however, exactly offset by expense items in the same sums to reflect the circumstance that CPL had swapped its right to receive $230m on 31 December 2008 for the interest payments received from Citibank NA, which in turn were brought into account as income. The detail, and result, of these receipts and expenses on income account will appear more clearly in due course, when we set out tabular representations of them which were included in the reasons of the primary Judge.

The primary judge's reasons

14. Early in his Honour's reasons, the primary Judge described the nature of the December transactions, and their consequences under Australian tax law, as follows:

"As will be seen, the relevant facts relating to the [transaction] did not give rise to any allowable deductions to CPL in Australia which were not available to it in Hong Kong, but the income base in Hong Kong in the year in which the [transaction was] consummated included the gross amount of the consideration received by the bond purchasing [partnership], of which CPL was a member, for the sale of the interest coupons … whereas the income base in Australia, while starting from the same point, was, by virtue of the application of the provisions of Div 16E of Pt III of the 1936 Act, spread over the life of the [bond] to equate with [its] treatment for financial accounting purposes. This meant that the income base in Hong Kong for [the transaction] in [the 2003 year] … included AUD60,495,296 …, whereas no amount was included in the income base in Australia for [the transaction] pursuant to Div 16E in the [2003] … (it having been consummated on the last day of the year of income) …. It is true that over the next five years … the balance was brought to account pursuant to Div 16E and included in the Australian income base of CPL in those years, but my purpose in noting the consequence in the [year] the [transaction was] consummated is to illustrate that there is, indeed, a measure of common ground between the examples in the extrinsic material and the facts of the present case."

The "extrinsic materials" to which his Honour referred were an announcement by the Commonwealth Treasurer on 13 August 1998 with respect to the then intended introduction of paras (bb) and (f) into s 177C(1), and of para (d) into s 177F(1), of the 1936 Act, and the Explanatory Memorandum for the Bill then introduced.

15. We should also mention, at this stage, some introductory remarks made by the primary Judge, in a section of his Honour's reasons which he headed "The Opening Salvos". His Honour said:

"17. In opening, CPL contended that a reasonable person could not conclude that the dominant purpose of a person making an actual payment of foreign tax was the acquisition of foreign tax credits in the same amount. That is evident, so CPL contended, because no rational taxpayer would pay a dollar of foreign tax simply to avoid an obligation to pay an equal amount of tax in Australia: why, one might ask, would the rational taxpayer be anything other than indifferent as to where it paid that tax?
18. So much may be conceded where the foreign tax on the relevant income is equal to or less than the Australian tax on that income; it may also be conceded where the foreign tax on the relevant income is greater than the Australian tax on that income by reason only of a greater foreign tax rate. But where, as here, the foreign tax rate (17.5%) is less than the Australian tax rate (30%) but the foreign income base, in the years in which the relevant transactions are entered into, is considerably greater than the Australian income base by reason of the different computation of those bases, resulting in greater foreign tax payable than the Australian tax that would otherwise be payable, giving rise to excess foreign tax credits, the door of inquiry under s 177D(b) as to the dominant purpose of a person entering into a scheme giving rise to a tax benefit in the form of those foreign tax credits, is not foreclosed by recourse to arguments based on the rationality of a taxpayer. It has to be determined by reference to the relevant matters or considerations set out in s 177D(b) and one of those matters or considerations will be whether the person has other foreign source income which has not borne foreign tax, or has borne foreign tax in an amount less than the applicable Australian tax, against which the excess foreign tax credits can be applied, in whole or in part, to reduce or otherwise relieve the Australian tax liability on the other foreign source income."

16. Turning to the deliberative section of the reasons of the primary Judge, his Honour first noted that the facts of the case were, for the most part, not in dispute, but that there were two issues of fact that required resolution. The first related to the margin, if any, which CPL earned by receipt of the periodical interest payments which arose under the swap arrangement with the Sydney branch of Citibank NA over the cost of funds in respect of the initial investment of $169,504,704, which was not to be repaid until 31 December 2008. On this point, his Honour referred to evidence, led by CPL, to the effect that it was not possible to calculate the specific expense associated with funding the acquisition of the bond, but that the annual financial reports of CPL did set out the interest rates which, on average, represented the cost of funding "CPL's general pool of funds". Applying those interest rates to the amount of the investment yielded, after five years, an aggregate funding cost of $45,037,388. Since the total of the interest payments received from Citibank NA over the same period was $52,870,576, CPL submitted that it had achieved a margin of some $7,833,178. The Commissioner did not accept that analysis, contending that the evidence was insufficient to demonstrate that CPL had derived any margin on the transactions in addition to the fee and the premium, net of the cost of the transactions itself. His Honour found that it was more likely than not that CPL did achieve a margin over the cost of funds used in the transactions, but added: "It is impossible, on the state of the evidence, to quantify that margin". He continued:

"The Court is therefore left with no alternative but to find that the pre-tax profit for CPL on HKBT 2003 was at least AUD6,493,512 and probably more, but how much more cannot be quantified. On the other hand, for reasons which I will come to, it is CPL's post-tax profit on HKBT 2003, both before and post foreign tax credit relief, which shed the more utile light on the matters to which regard is to be had in undertaking the process of drawing a conclusion of the kind mandated by s 177D."

It is to be noted that the sum referred to by his Honour - $6,493,512 - is the sum of the fee and the premium, less the transaction expenses, mentioned earlier in these reasons. It was, in effect, the net balance of the account on the sale of the interest coupons by BPP to CPP (although doubtless some part of the transaction expenses was proper to be apportioned to so much of the December transactions as related to the bond stub).

17. The second issue of fact upon which the primary Judge was required to make a finding related to CPL's expectation, on 31 December 2003, as to whether it would have other significant foreign income in the 2003 year. As mentioned above, it did have such income. As found by his Honour, Citicorp Life Insurance Ltd (formerly Metlife Insurance Ltd) which, from 1 January 2003, formed part of the group headed by CPL, returned foreign income of about $51m in 2002 and of $98,344,349 in 2003. Additionally, CPL itself had foreign interest income in the amount of $32,003,170 in 2003. These seemed to be uncontroversial facts. However, CPL's case below involved the proposition that it had no expectation of such income, with the result that his Honour ought to find that, objectively, it would not be concluded that it was a purpose of the scheme in question to increase the level of foreign tax against which the corresponding presumptive Australian tax could be set off for the purposes of s 160AF(1). The only witness whom CPL called on this question was someone whose understanding of the subject was indirect. His Honour did not accept her evidence, concluding:

"Whether that be right or not, I am not prepared, on her evidence, to make a finding that CPL, at the time it entered into the HKBTs, had little or no expectation of having any foreign source income other than what would be derived from the HKBTs themselves."

We would, with respect, regard his Honour's finding on this pure question of fact as unexceptionable. It is apparent that his Honour thereafter proceeded on the basis of an inference, which, in our view (particularly in the light of the onus of proof provisions of s 14ZZO of the Administration Act) was readily available, that CPL knew, in the period leading to 31 December 2003, of the probability that the other foreign income which it would return in the 2003 year would be such that the Australian tax paid in respect thereof (within the meaning of s 160AF(1)(e)) would amply account for the Hong Kong tax paid on the proceeds of the sales of the interest coupons.

18. The primary Judge then turned to the specific matters which required consideration under s 177D(b) of the 1936 Act. With respect to the manner in which the scheme was entered into or carried out, his Honour considered that the structure of the scheme was dictated by the guidelines of HK Internal Revenue. However, his Honour continued:

"But the identity of the participants in the structure, at least on the BPP… side, were not dictated by the Guidelines; they were dictated by the need for the participants, in particular the principal partner in the BPP… to be entitled to some form of relief in a jurisdiction outside Hong Kong to offset the post-tax loss in Hong Kong. That relief might take a number of forms, but one form it could take was by giving a credit in the jurisdiction of the principal partner's residence for the tax suffered in Hong Kong which might be applied against the tax liability of the principal partner in its jurisdiction of residence against other foreign source income which had not borne foreign tax at a rate equal to the jurisdiction of residence rate. In the relevant years of income, Div 18 of Pt III of the 1936 Act provided such relief."

His Honour then found that the choice of CPL as the principal partner in BPP was "explicable solely on the basis of the foreign tax credit regime in Australia". On appeal, this finding was not challenged by CPL.

19. Observing that the finding just referred to did not conclude the question arising under s 177D(b), the primary Judge turned next to the form and substance of the scheme. His Honour held that the complex form of the scheme was largely the result of the requirements of the HK Internal Revenue guidelines. The substance, however,

"… was more transparent and, in consequence, perceptibly simpler. In short, each scheme involved the subscription for an interest-bearing bond and the immediate sale of the interest coupons attached to the bond for a lump sum payment. That all occurred on day one and thereafter the stripped securities were continued to be held, although not necessarily by the day one parties, for the life of the bond. The financial and tax consequences for CPL over the life of the bond flowed from what occurred on day one …."

On appeal, CPL did not submit that his Honour here mischaracterised the substance of the scheme.

20. The primary Judge did not think that the time at which the scheme was entered into, or the length of the period during which the scheme was carried out, had any critical bearing on the conclusion which he should draw as to dominant purpose. However, his Honour added:

"That said, it is not without relevance that the HKBT 2003 was consummated on 31 December 2003, the last day of the first year of income that CPL filed an Australian income tax return on a consolidated basis, thus bringing within the filing fiscal entity sources of income, including foreign source of income, that hitherto would not have been included."

On appeal, it was not submitted on behalf of CPL that his Honour ought to have regarded that combination of circumstances as "without relevance".

21. The primary Judge next noted that it was common ground that the result of the scheme in relation to the operation of the 1936 Act, but for Part IVA thereof, would be a reduction in CPL's Australian tax in the 2003 year by an amount of $9,613,285. The only qualification that it is presently necessary to make in relation to that conclusion is that CPL did submit that the "result" proper to be taken into account under the 1936 Act should not be confined to the 2003 year, but should extend to the subsequent years in which CPL returned assessable income deriving directly or indirectly from its participation in the scheme. This aspect of the controversy was effectively the subject of the last of the matters arising under s 177D(b) which his Honour considered, and it is to that aspect that we next turn.

22. The primary Judge next considered the change, if any, in the financial position of CPL that resulted, would result, or might reasonably be expected to have resulted, from the scheme. His Honour noted that the scheme led to a pre-tax profit for CPL of at least about $6.5m (without the margin referred to in para 16 above) and of no more than about $14.3m (if the whole of the margin for which CPL contended had been achieved). However, his Honour also took the view that to approach the subject "without regard to the taxation costs of [the scheme's] implementation [would be] to ignore economic reality". Consequently, his Honour looked at the change in CPL's financial position as a result of the scheme at two levels: first, after taking into account CPL's liability to pay tax in Hong Kong and Australia, and secondly, after taking into account also the foreign tax credits to which CPL was entitled under Div 18. At each of these levels, his Honour considered the position by reference to two alternative assumptions: that the full margin for which CPL contended had been achieved, and that no margin at all had been achieved, respectively. This framework of examination yielded four tables which were based on tables made available to his Honour by CPL, as supplemented and amended by his Honour to cater for his immediate purpose.

23. As corrected in minor (and presently immaterial) respects, those four tables were as follows:

2003 HKBT Based on cashflows over life of transaction (inclusive of margin)

2003 HKBT Based on cashflows over life of transaction (inclusive of margin)
	2003	2004	2005	2006	2007	2008	Total
Income
Fee (1)	4,038,772						4,038,772
Premium (2)	3,317,439						3,317,439
Discount income (3)		12,099,059	12,099,059	12,099,059	12,099,059	12,099,059	60,495,296
Swap income (4)		9,330,265	9,585,667	9,893,758	11,201,192	12,859,694	52,870,576
Expenses
Swap expense (5)		(12,099,059)	(12,099,059)	(12,099,059)	(12,099,059)	(12,099,059)	(60,495,296)
Transaction costs (6)	(862,699)						(862,699)
Funding costs (7)		(7,610,761)	(8,153,176)	(8,644,739)	(9,780,421)	(10,848,301)	(45,037,398)
Pre-tax profit	6,493,512	1,719,504	1,432,491	1,249,019	1,420,771	2,011,393	14,326,690
Tax
Hong Kong	(11,561,339)						(11,561,339)
Australia (8)	(1,948,054)	(515,851)	(429,747)	(374,706)	(426,231)	(603,418)	(4,298,007)
Total tax before credit							(15,859.34)
Post-tax (loss) before foreign tax credit relief:							(1,532,456)

2003 HKBT Based on cashflows over life of transaction (absent margin)

2003 HKBT Based on cashflows over life of transaction (absent margin)
	2003	2004	2005	2006	2007	2008	Total
Income
Fee	4,038,772						4,038,772
Premium	3,317,439						3,317,439
Discount income		12,099,059	12,099,059	12,099,059	12,099,059	12,099,059	60,495,296
Expenses
Swap expense		(12,099,059)	(12,099,059)	(12,099,059)	(12,099,059)	(12,099,059)	(60,495,296)
Transaction costs	(862,699)						(862,699)
Pre-tax profit	6,493,512	NIL	NIL	NIL	NIL	NIL	6,493,512
Tax
Hong Kong	(11,561,339)						(11,561,339)
Australia (8)	(1,948,054)						(1,948,054)
Total tax before credit							(13,509,393)
Post-tax (loss) before foreign tax credit relief:							(7,015,881)

2003 HKBT Based on cashflows over life of transaction (inclusive of margin)

2003 HKBT Based on cashflows over life of transaction (inclusive of margin)
	2003	2004	2005	2006	2007	2008	Total
Pre-tax profit	6,493,512	1,719,504	1,432,491	1,249,019	1,420,771	2,011,393	14,326,690
Tax
Hong Kong	(11,561,339)						(11,561,339)
Australia (8)	(1,948,054)	(515,851)	(429,747)	(374,706)	(426,231)	(603,418)	(4,298,007)
Less FTCs	11,561,339						11,561,339
Tax paid							(4,298,007)
Post-tax profit after foreign tax credit relief:							10,028,683

2003 HKBT Based on cashflows over life of transaction (absent margin)

2003 HKBT Based on cashflows over life of transaction (absent margin)
	2003	2004	2005	2006	2007	2008	Total
Pre-tax profit	6,493,512	NIL	NIL	NIL	NIL	NIL	6,493,512
Tax
Hong Kong	(11,561,339)						(11,561,339)
Australia (8)	(1,948,054)						(1,948,054)
Less FTCs	11,561,339						11,561,339
Tax paid							(1,948,054)
Post-tax profit after foreign tax credit relief:							4,545,458

Notes

(1) Fee income recognised upfront for accounting and tax purposes.
(2) Premium income accrued over 5 years for accounting but recognised upfront for tax purposes.
(3) Discount income accrued for accounting and tax purposes pursuant to Division 16E.
(4) Actual amounts received pursuant to swap.
(5) Swap expense of $60,495,296 marked to market for accounting purposes and accrued over life of transaction for tax purposes.
(6) Taken up front for accounting and tax purposes.
(7) Funding costs cannot be precisely calculated. Estimate based on average interest rate on interest bearing liabilities over life of transaction.
(8) Australian Corporate tax rate of 30% applied to pre-tax profit.

24. His Honour observed that these tables demonstrated that, while the transaction -

"…. was pre-tax positive, it was post-tax negative prior to taking into account the foreign tax credits arising from the payment of Hong Kong Profits Tax on the transaction; this was so, irrespective of whether or not the pre-tax profit was inclusive of a 'margin' over cost of funds utilised in the transaction."

His Honour also noted that CPL's other foreign source income "facilitated the immediate utilisation of the foreign tax credits". He continued:

"In my view, these are matters which point strongly in the direction that the conclusion to be drawn by the Court under s 177D, having regard to the matters set out in subparas (i) to (v) inclusive of para (b) thereof, is that CPL entered into HKBT 2003, and it follows HKBT 2004, with the dominant purpose of obtaining a tax benefit in the form of those foreign tax credits."

His Honour observed that this conclusion was consistent with the evidence of Mr John Walker, who, at the relevant time, was employed in Sydney in the Global Capital Structuring division of the Citigroup group of companies, that, unless CPL were able to claim back the Hong Kong tax by way of a foreign tax credit in Australia, it would be "under water by $12 million". Mr Walker added: "So the transaction then made no sense. So it was critical that we actually broke even in a tax sense …." His Honour agreed that, absent the foreign tax credits, the transaction "did not make sense" invoking by way of analogy the similarly-worded conclusion expressed by Beaumont J in his dissent in
Commissioner of Taxation v Spotless Services Ltd 95 ATC 4775; (1995) 62 FCR 244, 271, approved by the High Court on appeal:
Commissioner of Taxation v Spotless Services Ltd 96 ATC 5201; (1996) 186 CLR 404, 422.

25. The primary Judge took the view that the considerations set out in subparas (vi), (vii) and (viii) of s 177D(b) were of no relevance to the case before him. Neither party suggested otherwise on appeal.

26. Substantially because of the primary Judge's consideration of the questions most recently dealt with above - those arising under subpara (v) of s 177D(b) - his Honour held, adversely to CPL, that it would be concluded that the dominant purpose for which CPL entered into and carried out the scheme was to obtain the tax benefit constituted by the foreign tax credit that was generated by the December transactions. His Honour dismissed the appeals which related to the Pt IVA determination and to the assessment, and took a like course with respect to the corresponding appeals for the 2004 year.

CPL'S Appeal

27. On appeal, it was submitted on behalf of CPL that the primary Judge had erred in three main respects. First, it was said that his Honour had applied an impermissible "but for" test to the question arising under s 177D(b). Secondly, it was said that the comparison referred to in the primary Judge's tables set out above was artificial and, in effect, misconceived, in that it treated as a separate situation that in which part only of the relevant tax law was brought into account - that which imposed tax - without also considering the provisions which provided a related tax credit. It was said that, if one arm of a comparison such as this was based on the application of Australian tax law, then all the relevant provisions should be brought into account. And thirdly, it was said that, to treat the December transactions as somehow generating "excess" foreign tax credits was to mischaracterise the situation, at least in the context of s 177D(b), since the transactions themselves generated sufficient foreign income (whether or not in the 2003 year) to utilise the corresponding credits. In this latter respect, the point was made that, if perchance there were other foreign income in the 2003 year which in fact absorbed the relevant credit, the later-year income flows (actual or deemed) would then not be "sheltered" by that credit.

28. Any consideration of these points raised by CPL must commence with the provisions of the 1936 Act, other than Pt IVA, that would otherwise be applicable in the circumstances. The present is within that class of case under s 177D in which the operation of the 1936 Act itself is an essential aspect of the objective process which that section mandates. The relevant provisions are to be found in Divs 16E and 18 of Pt III.

Division 16E

29. The bond purchased by BPP from Healthcote was a security within the meaning of Div 16E. In relation to that security, there were two "payment rights" within the meaning of s 159GZ(1), namely, the right to receive periodical interest payments under the coupons and the right to receive $230m on 31 December 2008. Upon the disposal of the former to CPP, the following provisions of s 159GZ(1) came into play:

"….

(c)[I]nstead of the underlying security, there shall be taken to have been originally issued:

(i) a separate security under which the payment right or payment rights transferred to the person or persons referred to in paragraph (b) were created;

(ii) where at the time at which that right or those rights were transferred, another payment right or other payment rights in relation to the underlying security was or were transferred to another person or to other persons jointly - a separate security under which that other right or those other rights were created; and

(iii) where immediately after the transfer the taxpayer retains or retained any payment right or rights - a separate security under which that right or those rights were created;

(d) where the underlying security was issued to the taxpayer - the issue price of each separate security referred to in paragraph (c) shall be taken to be so much of the issue price of the underlying security as bears to that amount the proportion that the market value of the separate security at the time of issue of the underlying security bears to the market value of the underlying security at that time; …."

That is to say, for the purposes of Div 16E, it was to be taken that Healthcote originally issued two securities to BPP as follows:

1. the interest coupons at an issue price of $60,495,296; and
2. the right to receive $230m on 31 December 2008 at an issue price of $169,504,704.

So much was common ground. It was also common ground that so much of the proceeds of the sale of the coupons to CPP as constituted the fee and the premium were returned as income by CPL in the 2003 year. However, beyond that point, there now appear to be important differences between the parties as to how Div 16E applied to the December transactions and to their consequences.

30. It appears to be uncontroversial that the fee of $4,038,772 was income in the hands of CPL according to ordinary concepts. How the premium came to be treated as assessable income was, however, the subject of a disagreement between the parties that was not revealed in the reasons of the primary Judge, and came to the surface - at least with clarity - only in memoranda which the parties filed after we had reserved judgment on the appeal. According to CPL, when BPP sold the interest coupons to CPP on 31 December 2003, a profit of $3,317,439 arose and was included in CPL's assessable income pursuant to s 159GS. By subs (1) of that section -

"s 159GS(1) as in 03

Where there is a profit amount in relation to the transfer of a qualifying security by a taxpayer in a year of income:

(a) if there is a net assessable amount in relation to the transfer and:

(i) the profit amount exceeds the net assessable amount - an amount equal to the excess shall be included in the assessable income of the taxpayer of the year of income; or

(ii) the net assessable amount exceeds the profit amount - an amount equal to the excess shall be allowable as a deduction from the assessable income of the taxpayer of the year of income; and

(b) if there is a net deductible amount in relation to the transfer - an amount equal to the sum of that amount and the profit amount shall be included in the assessable income of the taxpayer of the year of income."

In its memorandum, CPL did not descend into detail as to the fitting of the factual circumstances of the case into the requirements of s 159GS(1), but it is implicit that the premium achieved on the sale of the interest coupons was considered to be an "excess" of the kind referred to in subpara (i) of para (a).

31. In the memorandum filed on his behalf, the Commissioner did not accept this framework of analysis. It was submitted that a "profit amount" did not arise in relation to the transfer of a "qualifying security" within the meaning of s 159GS. The relevant definition of that term in s 159GP(1) required, amongst other things, that the security in question have what was referred to as "an eligible return", a term in turn defined in s 159GP(3) as follows:

"(3) For the purposes of this Division, there shall be taken to be an eligible return in relation to a security if at the time when the security is issued it is reasonably likely, by reason that the security was issued at a discount, bears deferred interest or is capital indexed or for any other reason, having regard to the terms of the security, for the sum of all payments (other than periodic interest payments) under the security to exceed the issue price of the security, and the amount of the eligible return is the amount of the excess."

The Commissioner submitted, without elaboration, that this definition was not satisfied in relation to the (deemed) security constituted by the interest coupons, with the result that s 159GS had no application to any profit derived from the sale of them. He submitted that the premium was indeed a component of CPL's assessable income for the 2003 year - and to that extent he agreed with CPL - but he contended that this was not because of s 159GS, but because the premium was income according to "ordinary concepts", and thus assessable under s 6-5 of the Income Tax Assessment Act 1997 (Cth) ("the 1997 Act").

32. Despite the differences between the parties to which we have just referred, it is probably sufficient for present purposes to proceed by reference to what is, on any view, common ground, namely, that the premium, or profit, which CPL derived from the sale of the interest coupons to CPP was, and was returned as, assessable income in the 2003 year.

33. However, the treatment of the balance of the proceeds of the sale of the interest coupons to CPP cannot be dealt with in a similarly robust way. In its memorandum filed after we had reserved judgment, having made the submission about the operation of s 159GS to which we have referred, CPL continued:

"[I]n relation to the security consisting of the right to receive the principal sum of AUD230,000,000 on 31 December 2008, the difference between that amount and the deemed issue price of that security (AUD169,504,704) was assessable income of the appellant, accrued over the life of the bond pursuant to section 159GQ (which deals with the taxation of accrued amounts over the life of the instrument).

In summary, contrary to the submission made on behalf of the respondent, the entire amount of USD50,400,000 received by BPP from CPP was returned as assessable income in both Hong Kong and Australia and it was not necessary for the appellant to have other foreign source income in order to be able to make use of the foreign tax credits generated by the payment of tax in Hong Kong on that income."

The "submission made on behalf of the respondent" referred to in this passage was the submission by the Commissioner that the balance of the sale proceeds of the interest coupons (ie other than the fee and the premium) was not returned as, and was not, assessable income in any year. That submission was reiterated in the memorandum filed recently on the Commissioner's behalf.

34. To understand, and to resolve, this difference between the parties requires a consideration of how Div 16E treated the second of the two deemed securities to which we have referred in para 29 above. As is clear from the first of the two paragraphs in the extract from CPL's memorandum set out above, it was submitted that the difference between $230m and $169,504,704 was assessable income spread over the life of the bond pursuant to s 159GQ of the 1936 Act. So much was accepted by the Commissioner, but he submitted that that difference was not the same thing as the balance of the proceeds of the sale of the interest coupons. For reasons which follow, we consider that this submission must be accepted.

35. The effect of s 159GZ(1)(c)(iii) of the 1936 Act, set out above, was that, upon the transfer of the interest coupons from BPP to CPP, it was to be taken that Healthcote had originally issued a separate security to BPP under which the rights which were not so transferred were created. The rights - or, more accurately, the right - not transferred was the right to receive $230m on 31 December 2008. When the coupons were stripped from the bond, the present value of the latter - now the stub - was reduced by the amount of the market value of the coupons ($60,495,296) to $169,504,704. That sum was the deemed issue price of the stub for the purposes of s 159GZ(1)(d) of the 1936 Act, which then fed into the calculation of the implicit interest rate under s 159GQC, the accrual amount under s 159GQB for each six-monthly period, and the amount to be included in CPL's assessable income under s 159GQ. Although the arithmetic required by these provisions was not laid out in the present appeal, it was common ground that the result was as indicated previously, namely, that the sum of $12,099,059 was included in CPL's assessable income in each of the years in question, making a total of $60,495,296. Since the December transactions were entered into at market on the one day, it was definitional that the Div 16E income instalments should in total equal the difference between the face value of the bond and the present value of the stub on 31 December 2003. As mentioned, the source of that difference was the market value of the coupons stripped from the bond.

36. It is this symmetry which, perhaps, gives plausibility to CPL's submission that the whole of the amount of $US50.4m ($67,851,507) was "returned as assessable income in both Hong Kong and Australia". In Hong Kong, the whole of the proceeds of the sale of the interest coupons was taxable. In Australia, the fee and the premium were assessable, as was the discount on the bond stub (under Div 16E). Thus it is correct to say that CPL returned in each jurisdiction (as profits in Hong Kong and as income in Australia) the sum of $67,851,507. However, the balance of the proceeds of the sale of the coupons (ie after allowing for the fee and the premium) was no more than the return of part of the price which CPL had, on the same day, paid for the bond. That sum was not assessable as income in Australia, and was not returned as such. What CPL did return was the discount on the stub. Although that discount had its source, and quantification, in the market value of the coupons sold to CPP, it was, in our view, not one and the same thing as the balance of the proceeds received for the coupons.

37. Although it is important to understand the issues just discussed, ultimately it would be a mistake to assume that the question arising on the present appeal will necessarily turn on whether CPL paid both Australian and Hong Kong tax on the same receipt (to use a neutral term). Why that would be so, in the context of Pt IVA, is a matter which requires consideration also of the provisions of Div 18, to which we next turn.

Division 18

38. We commence with s 160AF, the relevant terms of subs (1) whereof we have set out at para 4 above. By subs (7) of that section, where the foreign income in question consisted of two or more of the classes of income there set out (including "passive income", "offshore banking income" and "other income"), the section was to be applied separately in relation to each of the classes of income. It was not clear whether CPL's foreign income in the 2003 year included income in two or more of the specified classes, but it seems that nothing turns on that. To the extent that subs (7) did apply in the circumstances, it seems to have been assumed that the other foreign income that CPL derived in the 2003 year fell within the same class as the foreign income which was derived from the December transactions.

39. Relevantly to the present case, subs (1) of s 160AF was concerned with so much of the taxpayer's assessable income in respect of which the taxpayer had paid foreign tax. It was the latter entity which was to be used in the comparison required by paras (d) and (e). The first purpose of identifying the foreign income, therefore, was to fix an amount of foreign tax which was then to be carried into para (d). Next, "the amount of Australian tax payable in respect of that income" was to be calculated under para (e). That expression was a term of art under Div 18, being defined in s 160AF(3). To the extent presently relevant, subs (3) provided as follows:

"(3) For the purposes of subsection (1), the amount of Australian tax payable in respect of foreign income by a taxpayer in a year of income is, subject to the succeeding provisions of this section, an amount ascertained by:

"(a) applying the average rate of Australian tax of the taxpayer of the year of income to the adjusted net foreign income of the taxpayer of the year of income; and

(b) deducting from the resulting amount the sum of any rebate (other than a rebate under an Act fixing the rates of income tax, or under an Act imposing income tax, for the year of tax) to which the taxpayer is entitled in the taxpayer's assessment in respect of income derived in the year of income and which relates exclusively to so much of that income as is foreign income."

The term "average rate of Australian tax" was defined in s 160AF(8), but not so as to involve any such departure from what might be considered the natural meaning of the term as presently requires comment. So too was the term "adjusted net foreign income" defined, and that definition in turn made use of the concept of "net foreign income", which was defined (to the extent presently relevant) to mean -

"… an amount equal to so much of the taxpayer's assessable income of the year of income as is foreign income, reduced by:

(a) any deductions allowed or allowable from that assessable income (other than any relevant debt deductions) that relate exclusively to that foreign income;"

What was significant in this definition - at least in the submission advanced on behalf of CPL - was the exclusion of "relevant debt deductions". What would constitute a "debt deduction" would seem to be a question of some complexity, and, because the subject was not developed in the parties' submissions, we do not propose to enter upon it. It is sufficient to say that, at least in the case of CPL, the exclusion of debt deductions had the potential to make the amount worked out under para (e) of s 160AF(1) somewhat larger than the amount of Australian tax that was in fact assessed on the relevant income.

40. The other section in Div 18 which requires mention is s 160AFE. At the time, it provided as follows:

"(1) This section operates if the amount (the current foreign tax amount) worked out under paragraph 160AF(1)(d) for a taxpayer for a year of income (the current year) falls short of the amount worked out under paragraph 160AF(1)(e) for the taxpayer for the current year.

(2) The taxpayer's excess foreign tax credits from earlier years of income (see subsection (4)) are applied in accordance with subsection (3) to increase the current foreign tax amount.

(3) Apply those credits according to the following rules:

(a) only apply credits from the most recent 5 years of income ending before the current year;

(b) apply credits from an earlier year of income before applying credits for a later year of income;

(c) do not apply credits beyond the extent of the shortfall mentioned in subsection (1);

(d) do not apply credits to the extent that the credits have already been applied under a previous operation of this section.

(4) The taxpayer has excess foreign tax credits from an earlier year of income (the earlier year) if the amount worked out under paragraph 160AF(1)(d) for the taxpayer for the earlier year exceeds the amount worked out under paragraph 160AF(1)(e) for the taxpayer for the earlier year. The amount of the credits equals the excess.

(5) This section operates separately in relation to each class of foreign income identified in subsection 160AF(7), as if the taxpayer's foreign income of that class for a year of income were the whole of the taxpayer's foreign income for that year."

Under s 160AFE(4), if the amount of foreign tax as worked out under s 160AF(1)(d) was greater than the amount of Australian tax payable as worked out under s 160AF(1)(e), the taxpayer had "excess foreign credits" which could be carried forward for a maximum of five years and used in a year in which the amount of foreign tax fell short of the amount of Australian tax payable with respect to the same class of foreign income (see s 160AF(7)) as gave rise to the excess foreign credits.

41. The way in which s 160AF and 160AFE worked together was more or less as follows. In a year of income, if the amount of foreign tax were less than the amount of Australian tax payable on the corresponding foreign income, the former would stand as the credit under s 160AF(1), and s 160AFE would not enter the picture. If the amount of foreign tax were greater than the amount of Australian tax payable on the corresponding foreign income, the latter would stand as the credit under s 160AF(1). In this second situation, the excess of the foreign tax over the Australian tax could be carried forward to a subsequent year under s 160AFE, but could only be applied to the figure which represented the amount of foreign tax under s 160AF(1)(d) in that year, and then only to the extent necessary to bring that figure up to the amount of Australian tax payable. Thus it may be seen that an increase in the amount worked out under para (d) of s 160AF(1) would have been to the direct benefit of a taxpayer in a particular year, so long as that amount did not exceed the amount worked out under para (e). Once that point was passed, adding further foreign tax to the amount in para (d) would have been of no benefit in that year, but the excess might have been of benefit in a subsequent year under s 160AFE.

42. On the facts of the present case, in the 2003 year CPL's assessable income included foreign income on which foreign tax had been paid. That circumstance enlivened the operation of s 160AF(1). It meant that the comparison required by paras (d) and (e) had to be carried out. A contributor to the amount referred to in para (d) was the $11,561,339 paid as tax in Hong Kong on the proceeds of the sale of the interest coupons to CPP. This was accepted by the Commissioner as the amount of foreign tax that was paid "in respect of" so much of the corresponding foreign income as was included in CPL's assessable income within the meaning of para (b) of the subsection. A contributor to the amount referred to in para (e) was "the amount of Australian tax payable in respect of" that component of foreign income. We were told by counsel for CPL that this amount was more than the amount referred to in para (d) in respect of that component, such that the latter - $11,561,339 - stood as the credit under the subsection. However, s 160AF(1)(d) and (e) did not require a comparison between the foreign tax and the amount of Australian tax payable in respect of a particular gain: they required a comparison between the totality of a taxpayer's foreign tax paid in the year in question and the amount of Australian tax payable in respect of the totality of the corresponding foreign income. This is, in our view, a significant point, particularly where s 160AFE may be relevant.

43. In the 2003 year CPL claimed a foreign tax credit of $12,421,815, of which $11,561,339 represented the Hong Kong tax paid on the proceeds of the sale of the interest coupons. For CPL to have claimed that credit - and it is accepted that, absent the Commissioner's determination under Pt IVA, such a credit would have been allowable - the amount worked out under para (d) of s 160AF(1) must still have been less than the amount worked out under para (e) thereof. That is to say, the s 160AF(1) credit in the present case was based on the amount of foreign tax actually paid in total in the 2003 year, rather than on the amount of Australian tax payable in total on the corresponding foreign income in that year. It necessarily follows, first, that when CPL brought the Hong Kong tax into account under s 160AF(1)(d), it derived an immediate after-tax benefit in the sum of $11,561,339 (subject to the transaction expense which it was required to meet), and secondly, that no amount was carried forward into subsequent years under s 160AFE.

CPL'S Dominant purpose

44. That brings us to the application of Pt IVA to the facts of the case, given the operation of Divs 16E and 18 in the way described above. "[T]he inquiry directed by Pt IVA requires comparison between the scheme in question and an alternative postulate":
Commissioner of Taxation v Hart (2004) 217 CLR at 243 [66] per Gummow and Hayne JJ. The present case was conducted on the basis that the alternative postulate was that CPL would not have entered into the scheme. That is to say, there was no positive counterfactual proposed. The inquiry directed by Pt IVA was, therefore, whether it would be concluded that CPL undertook the December transactions for the dominant purpose of obtaining a foreign tax credit, by comparison with not undertaking any such transactions at all.

45. In embarking upon that inquiry, there are three features of the present case which might usefully be noted. First, although the scheme itself was somewhat complex considered as a series of related transactions, to make the assessment mandated by s 177D does not require a broader understanding of the commercial or financial environment in which CPL found itself, save to note, as we have, that other foreign income of the relevant class was received, and was anticipated, in the 2003 year. Both at first instance and on appeal, the focus of the parties was on the narrow questions of how CPL stood to gain from the scheme, and of how those gains threw light on its inferred dominant purpose. Secondly, although, as noted above, there was a factual issue before the primary Judge as to whether CPL had earned a margin on the interest it received from Citibank NA over the relevant cost of funds, it was not suggested on appeal that such commercial gain as CPL may have derived thereby was relevant to the identification of its dominant purpose under s 177D. CPL's case was that, possessed of a fixed-interest security the return on which reflected nothing more than the difference between the face value and the present value of the bond stub, it undertook the Citibank NA swap because it preferred to be exposed to market fluctuations in interest rates. That preference was not advanced as carrying any relevant consequences for the matter which the primary Judge was required to determine under Pt IVA. And thirdly, the transactions were all conducted "at market". That is to say, there was nothing about the transactions which suggested that any of the parties to them had either the intention or the ability to trade in securities for other than their market values as they existed on 31 December 2003.

46. It was CPL's case on appeal that the December transactions were undertaken for the uncomplicated purpose of deriving the fee and the premium on the sale of the interest coupons to CPP. However, as Mr Walker made clear in his evidence to the primary Judge, it was an essential condition of the viability of the transactions that a foreign tax credit be obtained in relation to the profits tax paid in Hong Kong. And so it was: there would be no rational basis for pursuing a gain of $7,356,211, which would then be assessable as income in Australia, if it meant paying $11,561,339 as tax in Hong Kong. If that tax liability could be neutralised, in effect, under Div 18, the transactions then made sense from a purely commercial perspective. That was CPL's case. But this line of analysis, in our view, leaves a significant question out of the mix: from where did the fee and premium actually come?

47. A striking feature of the December transactions was that CPP paid the equivalent of $67,851,507 for an asset which then had a market value of $60,495,296. Objectively, it must be asked why a sophisticated financial institution such as BoC presumably was would act in this way. It should also be inquired how this excess over market value was funded. When questions of this kind arose during the hearing of the appeal, senior counsel for the Commissioner responded in the following terms:

"So if everything else is at market and Hong Kong is not funding the transaction in any real sense, where then does the money come from? And the real answer to that is that the money comes from the Australian revenue. The Australian consolidated revenue in substance through the tax credit. That's where the money is."

In their submissions in reply, we did not understand counsel for CPL to come squarely to terms with this proposition.

48. The means by which the commercial gain - for BoC as well as for CPL, as it happens - arose from the December transactions may be revealed as follows. It is common ground that it was the Hong Kong tax deduction that made the December transactions attractive for BoC. BoC was, in effect, prepared to share its gain from the deduction with CPL, the fee and the premium amounting to $7,356,211. However, the tax deduction was available only if BPP paid the corresponding tax on the sale proceeds, namely, $11,561,339. The funding of that payment, in turn, was by way of CPL's credit arising under Div 18 of Pt III of the 1936 Act. That credit, and the existence of other foreign income against which to set that credit off - thus effectively turning the credit into cash - made the transactions both viable and profitable, for BoC and for CPL. There was no commercial or financial source of profit or gain which stood apart from the fiscal considerations underlying the December transactions. When the matter is viewed in this way, the proposition advanced on behalf of the Commissioner that the funds for the transactions came from the Australian revenue by way of the Div 18 credit is almost self-evident. Indeed, for CPL to have had the dominant purpose of obtaining the foreign tax credit is not inconsistent with it having had the purpose of deriving the commercial gain represented by the fee and the premium: achievement of the latter purpose was proper to be seen as dependant upon achievement of the former.

CPL'S Criticisms of the primary judge's reasons

49. It is in the light of this perception of the scheme that we turn to CPL's criticisms of the reasons of the primary Judge, commencing with what was said to be his Honour's adoption of the impermissible "but for" test. It is true that it is not enough, in the application of s 177D, to consider whether a taxpayer would have entered into the putative scheme "but for" the tax benefit postulated:
British American Tobacco Australia Services Ltd v Commissioner of Taxation (2010) 189 FCR 151, 162 [46]. But that is not because an approach to decision-making which employs thinking of the kind exemplified by the test is irretrievably toxic of itself: it is, as the Full Court pointed out in the case referred to, because Part IVA does not require recourse to such a test, and the substitution of it for what is required by s 177D would involve a misdirection. As demonstrated above, in the present case the primary Judge's reasons were structured conventionally by reference to the (relevant) factors listed in s 177(b). Indeed, at one point his Honour referred to Hart and continued:

"What these extracts from their Honours' reasons in Hart go to exemplify is that the task for the Court under s 177D(b) in drawing a conclusion as to the dominant purpose of a taxpayer in entering into or carrying out a scheme is not to be determined by reference to whether it represents a 'rational commercial decision' or that the scheme has a 'commercial end', any more than it is to be determined by reference to the fact, if it be a fact, that a taxpayer adopted one of two alternative courses of action, being the one that produces a tax benefit. Moreover, I do not read their Honours' articulation of the test in Spotless at 423 namely '… that, viewed objectively, it 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', as embracing a 'but for' test; the requisite dominant purpose is not to be drawn merely because, as a matter of objective fact, it is to be concluded that 'but for' the tax benefit the course of action adopted would not have been adopted or that 'but for' the tax benefit, another course of action would have been adopted, although those considerations may be relevant to the conclusion as to the alternative postulate or hypothetical construct by reference to which the 'tax benefit', if any, may be measured."

This passage bespeaks a conventional approach to the exercise which s 177D requires, and attracted no criticism from CPL. Notwithstanding that, should we accept CPL's submission that, in the deliberative part of his reasons, his Honour effectively turned his back on what he said here and did apply the "but for" test?

50. The parts of his Honour's reasons on which CPL relied in this respect were those to which we have referred at para 24 above. Specifically, his Honour's reliance on Mr Walker's evidence that, absent the tax credits, CPL would be "under water by $12 million", and his Honour's adoption of the "did not make sense" formula from Spotless were said to demonstrate that, in this crucial part of his reasons, his Honour utilised the "but for" test.

51. In Spotless, their Honours in the joint judgment said (186 CLR at 422):

"Beaumont J, in his dissenting judgment, held that the form and substance of the EPBC proposal had been to take steps to ensure that the source of the interest was located in the Cook Islands. The 'dominant purpose' of the taxpayers in doing this was to achieve a tax benefit in Australia in the form of the exemption under s 23(q) of the Act. Without that benefit, the proposal would have 'made no sense'. We agree with those conclusions."

In the present case, it was submitted on behalf of CPL that, in Spotless, the investment itself was inherently uncommercial because it returned interest at a rate substantially below other comparable rates, and was rendered commercial only by the operation of an exemption under s 23(q) of the 1936 Act. By contrast, said CPL, the December transactions yielded a commercial return before any tax considerations were taken into account: the fee and the premium achieved on the sale of the interest coupons. CPL did not retreat from Mr Walker's "under water" observation. Indeed, it submitted that it was both obvious and unexceptionable that it should have desired to obtain an Australian credit in respect of what was otherwise a major negative of the contemplated transactions: the payment of tax on a receipt which was not a taxable gain under Australian law.

52. It will be apparent from what we have already written that we do not accept CPL's proposition that the fee and the premium were by way of a conventional non-tax-related commercial return. To the contrary: they were ultimately generated by the Div 18 credit which CPL achieved against its liability to pay Australian tax in the 2003 year. We consider, with respect, that the primary Judge was very close to the mark when he invoked Beaumont J's observation in Spotless, and that his use of the "did not make sense" formula rightly related to purpose, and not merely to a condition. His Honour's reasons do not, in our respectful view, betray a substitution of the "but for" test for the conventional test of purpose required by s 177D.

53. Turning to CPL's second point of criticism which we have identified in para 27 above, we accept that, in the tables prepared by the primary Judge, his Honour compared three situations: (1) one in which the transactions were undertaken, but no tax was paid at all; (2) one in which the transactions were undertaken and Australian and Hong Kong tax was paid, but no foreign tax credit was available; and (3) one in which that tax was paid, and the foreign tax credit was available and availed of. CPL submitted that the second situation could not properly serve as a comparator because, however conscientious it was to avoid having the purpose to which s 177D refers, it was a situation which it could never bring about. Once it paid the tax in Hong Kong, a credit arose under s 160AF. Any comparison which involved as one of the comparators a situation in which the Hong Kong tax was paid but the Australian foreign tax credit was not available could not, in the submission of CPL, perform any kind of sensible service under s 177D. On a proper analysis, according to CPL, the objective circumstances were much more simple than his Honour's tables suggested. Before tax, the December transactions were profitable, a circumstance which implied a benign purpose under s 177D; beyond that, the after-tax situation arose because of the non-discretionary operation of the 1936 Act, and was not such as might contradict or qualify that implication.

54. Had the primary Judge made use of the second situation as a counterfactual for the purposes of s 177D, there would have been considerable force in CPL's criticism. However, we do not believe that his Honour included the tables in his reasons for that purpose. CPL's criticism of his Honour's use of the tables is valid only if the fee and the premium are assumed to be free-standing gains generated by the December transactions from non-tax sources. As we have attempted to explain, they did not have that character. When the December transactions are viewed through the appropriate prism, there is a sense in which his Honour's comparison - of the post-tax results both before and after the application of the foreign tax credit - is legitimate. It does not seem to be so if the credit is viewed as no more than the mirror image of the tax paid in Hong Kong. But it is more obviously so when the credit is viewed as the underlying source of funding for the transactions as a whole. CPL's approach, which stressed that its purpose could not have been to obtain the credit, since that would do no more than offset tax paid in Hong Kong, is altogether too narrow for the purposes of s 177D. It looks only at a particular cross-section of the transactions, that which involves the payment of the Hong Kong tax and the availability of the Div 18 credit. By so doing, it deflects attention away from the underlying characteristics, and drivers, of the transactions as a whole.

55. CPL's third point referred to in para 27 above was (to quote from its written outline) that the December transactions "did not generate 'excess' [foreign tax credits] … because the transaction[s] [themselves] generated sufficient foreign source income against which the credits were to be applied". As so expressed, it will be seen that the point was concerned with the excess of foreign tax over Australian tax with respect to the transactions themselves, rather than, as required by s 160AF, with respect to the foreign income earned by CPL in a particular year. It is true that "excess" was used in this sense in the extrinsic materials referred to in the primary Judge's reasons: see para 14 above. However, we do not believe that his Honour used the term in this sense in the deliberative part of his reasons. In this respect, we consider that the heading to the relevant section of CPL's written outline in the appeal - "The Alleged Generation of 'excess' foreign tax credits in those years" - misleadingly conveyed the impression that his Honour's reasons carried such an allegation.

56. However, as developed on the hearing of the appeal, it appeared that the essence of the point was an attack on his Honour's having had recourse, as part of his inference of purpose under s 177D, to the circumstance that CPL had other foreign income in the 2003 year which "facilitated the immediate utilisation of the foreign tax credits". That such was the fact was not in contest. CPL's point, rather, was that, if the whole of the credit arising from the payment of Hong Kong tax in the 2003 year was thus immediately "utilised", his Honour ought to have recognised that there was a corresponding detriment, in effect, brought about by the unavailability of any part of that credit to "shelter" the Div 16E income accruals, which were also foreign income derived as a result of the scheme. At most, the possibility of immediate utilisation was said to be a matter of timing only. His Honour ought to have regarded it, in effect, as a trifle which ought not to bear upon the purpose of the scheme as would be inferred from the objective facts.

57. CPL gave emphasis to its point by referring to a memorandum written by Mr Walker and one of his colleagues on 9 December 2003, in which the following table of foreign tax credit utilisation steps was set out:

Foreign Income Analysis

Year 0 1 2 3 4 5

Foreign Source Income 13.658.537 13,658,537 13,658,537 13,658,537 13,658,537

Less Foreign Deductions 0 0 0 0 0

Net Foreign Source Income 13,658,537 13,658,537 13,658,537 13,658,537 13,658,537

Australian Tax Payable (30%) 4,097,561 4,097,561 4,097,561 4,097,561 4,097,561

Less Foreign Tax Credits -4,097,561 -4,097,561 -3,756,098 0 0

Net Australian Tax Payable 0 0 0 341,463 4,097,561 4,097,561

FTC carried forward 11,951,220 7,853,659 3,756,098 0 0 0

The figures in this table differed from those generated by the December transactions as actually carried out, but that is of no moment. CPL's point was that, as a matter of analysis, it was anticipated, before the event, that so much of the foreign tax credit as was not utilised in the 2003 year as such - and, under the table, that was the whole of the credit - would be set off against the Australian tax that would otherwise be payable on the successive instalments of Div 16E income. So understood, the December transactions themselves would generate sufficient foreign income to utilise the credits within three years. If, as things turned out, the whole of the credit were utilised in the 2003 year itself, this Div 16E income would then be "unsheltered".

58. Although the primary Judge referred to Mr Walker's memorandum in his recitation of the facts, his Honour did not mention it in the deliberative section of his reasons. With respect, we would regard that as a cause for neither surprise nor concern. The table is both theoretical and problematic. It is theoretical because it treats the December transactions as the source of the only foreign income of the relevant class which CPL might have had in the years in question. It is problematic because it is based on the proposition that merely by paying foreign tax in a stated sum at or near the end of an Australian fiscal year, a taxpayer becomes entitled to set the same sum off against Australian tax that would otherwise be payable on related income instalments in subsequent years. That was not the way Div 18 worked.

59. For the outcome postulated by Mr Walker's table (and by the corresponding submissions made by CPL on appeal) to have come about, it would have been necessary for the amount worked out under para (d) of s 160AF(1) in the 2003 year to have exceeded the amount worked out under para (e) thereof by the sum of $11,951,220 (the amount of foreign tax arising under the December transactions as such - $11,561,339 as it turned out). Only a sum arising from such an excess could be carried forward under s 160AFE. On the (theoretical) assumption that CPL had no other foreign income of the relevant class in the 2003 year, there would have been no such excess. We were assured by counsel for CPL that, for the income yielded by the December transactions as such, the amount worked out under para (d) was less than the amount worked out under para (e). In such a situation, the amount of the foreign tax would represent the credit arising under s 160AF(1), and no carry-over of "excess" credits under s 160AFE would occur.

60. Turning from the theoretical to the actual, as things happened, the amount worked out under para (e) of s 160AF(1) was greater than the amount worked out under para (d) thereof in the 2003 year, taking into account all of the foreign income derived by CPL of the relevant class. That is why, subject only to the transaction expenses, every dollar of the tax paid in Hong Kong was of immediate benefit to CPL in that year. Section 160AFE was not brought into play. And it could not have been brought into play unless there was some particular pattern of foreign income that would have produced the result that, in total, the amount worked out under para (d) exceeded the amount worked out under para (e). Our attention was drawn to nothing in the evidence before the primary Judge which would provide the basis for any such hypothetical pattern of foreign income. Rather, CPL's submission implicitly invited us to consider it self-evident that, absent other foreign income in the 2003 year, the whole of the tax paid in Hong Kong would stand as a kind of "credit" which could be carried forward beyond that year as a "shelter" for the Div 16E instalments. As we have attempted to demonstrate, this submission cannot be accepted.

61. There are other reasons why CPL's third point should be rejected. The first is that it implicitly invokes the wrong comparison. It invites the court to deal with the primary Judge's reliance on the existence of other foreign income in the 2003 year as though the relevant alternative was that there was no such income in that year. However, under s 177D, we are not entitled to proceed in this way. We must take the facts as the primary Judge found them. We must accept that there was the other foreign income to which his Honour referred. As indicated earlier, the alternative postulate is that the scheme was not entered into. That is to say, given the facts as found by his Honour, would it be concluded that the dominant purpose of CPL in entering into the scheme was to obtain the foreign tax credit? The existence of the other foreign income goes a considerable distance towards resolving that question in the affirmative. It is, in our view, to be inferred that CPL would have recognised the 2003 year as one in which the amount worked out under para (e), would be considerably greater than the amount worked out under para (d), of s 160AF(1). CPL would have realised that an excess of the para (e) amount over the para (d) amount could not be carried forward under s 160AFE, and that it had, therefore, a once-only opportunity to use that excess to advantage. It would have perceived in the scheme a means by which to avail itself of that opportunity.

62. The force of the primary Judge's comment that CPL's other foreign income in the 2003 year "facilitated the immediate utilisation of the foreign tax credits" was not that it drew attention to a situation which was more advantageous to CPL than one in which there was no other foreign income. Rather, it was that it highlighted why, in the circumstances actually existing, it was advantageous to obtain the foreign tax credits. The comment was not erroneous, misconceived or irrelevant. In our view, it drew attention to a circumstance that was of some force in the objective assessment required by s 177D.

63. Another reason why CPL's third point should be rejected is that proposed by the Commissioner. It relates to the proposition, on which the point was based, that, in the years subsequent to the 2003 year, CPL would derive Div 16E income on which the Australian tax would, in the normal course, have to be paid. It was against this potential liability for Australian tax that the foreign tax credit carried over from the 2003 year (assuming there were any) would, it was said by CPL, provide some "shelter". The Commissioner's submission ran thus (and here we refer to the written outline filed on his behalf):

"The appellant also contends that the actual application of the foreign tax credits against other foreign source income left 'unsheltered' the Division 16E income to be derived over five years. This contention is not sustainable. It was a constituent step of the schemes that the Division 16E income was matched and hence completely offset by the swap expense. As a consequence no tax was payable on the Division 16E income, hence no 'sheltering' was necessary."

The factual basis of this submission is to be seen most clearly from the primary Judge's tables. Each instalment of "discount income" is exactly offset by a "swap expense" item in the same sum. It follows, according to the Commissioner, that the Div 16E instalments would never have contributed to CPL's taxable income and would never, therefore, have required sheltering from Australian tax by any excess Div 18 credit carried forward from the 2003 year.

64. CPL's rejoinder was to submit that the Commissioner misunderstood how the tax laws worked. Any deduction to which CPL was entitled by way of "swap expense" was to be applied to its assessable income generally. It did not have the effect of eliminating the Div 16E instalments for the purposes of Div 18. Section 160AF worked by reference to a taxpayer's assessable income, and the existence of the deductions could not affect the conclusion that the instalments were part of that income, and were foreign income. Thus a credit arose which was, within the limits of Div 18, to be applied to the amount of tax that would be payable on the instalments, and this was not affected by the circumstance that deductions, to be applied generally across CPL's assessable income, happened to be generated by the swap with Citibank NA.

65. CPL further pointed out that Div 18 made a very particular kind of provision for the treatment of deductions, or potential deductions, which might be relevant to foreign income on which foreign tax had been paid. In working out "the amount of Australian tax payable" under s 160AF(1)(e), one utilised the concept of "net foreign income" (see s 160AF(3)), a term so defined in s 160AF(8) as to take account of deductions allowable in Australia "that relate exclusively to that foreign income". However, "relevant debt deductions" were excluded from this calculation. Counsel for CPL asserted that the "swap expense" was a "relevant debt deduction" and, therefore, was not to be subtracted from CPL's foreign income for the purpose of the calculation required by s 160AF(3). The result would be that, in a year subsequent to the 2003 year, the amount worked out under para (e) of s 160AF(1) would be higher than it otherwise might be, and that more of the credits carried forward under s 160AFE might be available to augment the sum worked out under para (d) of s 160AF(1) until the limit set by s 160AFE(3)(c) was reached.

66. In our view, CPL's submission amounts to no answer to the Commissioner's point. There can be no doubt but that each Div 16E instalment was exactly offset by a conventional deduction in the same amount. The fiscal reality was that CPL would pay no Australian tax on those instalments. It may be that the deductions would be applied to the assessable income of CPL generally, rather than to the instalments specifically, but, absent the instalments and the swap, there would have been no deductions. The scheme was structured such that the instalments would not form part of CPL's taxable income. The notion that they needed some kind of "shelter" is, in our view, at best theoretical and goes no way towards compromising the practical utility of the contribution of the other foreign income in the 2003 year to the analysis required by s 177D. The primary Judge was not in error to have made use of that contribution.

67. For the above reasons, we would reject the third respect in which CPL criticised the reasoning of the primary Judge.

Disposition of CPL's appeal

68. In our view, the primary Judge was not in error in his disposition of CPL's appeals under s 14ZZ of the Administration Act. With respect, we consider that his Honour's reasons disclose a sound objective determination of purpose such as is required by s 177D of the 1936 Act. Although that conclusion would be sufficient for present purposes, because of the way the case was conducted on appeal, we would add that we are in no doubt that his Honour's decision was the correct one in all the circumstances. For reasons which we shortly stated at paras 45-48 above, we consider that obtaining a foreign tax credit in the 2003 year was more than a condition of the viability of the scheme: it was ultimately the commercial engine which drove the scheme. By reference particularly to the matters covered by subparas (ii) (substance of the scheme), (iii), (iv) and (v) of s 177D(b) of the 1936 Act, we are satisfied that the dominant purpose of CPL for entering into and carrying out the scheme was to obtain the foreign tax credit generated by the payment of Hong Kong tax on the sale of the interest coupons to CPP.

69. For the reasons given above, we would dismiss CPL's Pt IVA appeal in respect of the 2003 year. It was accepted that the circumstances of the 2004 year were not to be distinguished, in which event we would dismiss that appeal also. No discrete grounds of appeal were advanced with respect to the penalty proceedings (that referred to in the second bullet point in para 1 above and the corresponding one for the 2004 year), the disposition of which should follow the dismissal of the Pt IVA appeals. Conventionally, the Commissioner would be entitled to his costs, and we shall so order, but, lest there be some particular circumstance affecting that entitlement of which we are unaware, we shall stay that costs order for 14 days and give the parties liberty to apply.

The Commissioner's Appeal - General interest charge

70. The Commissioner's appeal involves the construction, and the operation, of subss (1A) and (3) of s 204 of the 1936 Act, which (at the relevant times) provided as follows:

"(1A) Subject to the provisions of this Part, the tax payable by a full self-assessment taxpayer for a year of income becomes due and payable as follows:

(a) if the taxpayer's year of income ends on 30 June - on 1 December of the following year of income or on such later date as the Commissioner allows by notice published in the Gazette;

(b) if the taxpayer's year of income ends on a day other than 30 June - on the first day of the sixth month of the following year of income, or on such later date as the Commissioner allows by notice published in the Gazette.

….

(3) If any of the tax or shortfall interest charge which a person is liable to pay remains unpaid after the time by which the tax or charge is due to be paid, the person is liable to pay the general interest charge on the unpaid amount for each day in the period that:

(a) started at the beginning of the day by which the tax or shortfall interest charge was due to be paid; and

(b) finishes at the end of the last day on which, at the end of the day, any of the following remains unpaid:

(i) the tax or shortfall interest charge;

(ii) general interest charge on any of the tax or shortfall interest charge."

The Commissioner's case was that, upon the making of the amended foreign tax credits determination under s 160AK, the tax which CPL was liable to pay for the purposes of s 204(3) was the tax which would have been payable in the absence of the credits originally claimed. Because that tax had not been paid on the dates specified in s 204(1A)(b) (ie for the 2003 year and the 2004 year), the general interest charge was payable under s 204(3). It was accepted that the amended determinations made no difference to CPL's tax as assessed, but it was said that they increased the tax that CPL was "liable to pay" within the meaning of s 204(3).

71. The primary Judge - before whom, we were advised by counsel for the Commissioner, the relevant arguments were less developed than those advanced on appeal - noted that the amended determinations were not amended assessments (s 160AI(2)), and that s 160AN provided a system for the recovery of foreign tax credits, for the application of such credits in partial discharge of a taxpayer's tax liability and for the recovery of credits by the Commissioner in the case of amended determinations. To the extent relevant, the provisions of s 160AN were as follows:

"(1) The amount of a credit is a debt due and payable to the person entitled to the credit by the Commissioner on behalf of the Commonwealth.

(3) If, under Division 3 of Part IIB of the Taxation Administration Act 1953, the Commissioner has applied an amount of credit in discharge of a liability of a person to the Commonwealth, that person shall be deemed to have paid the amount so applied for the purpose for which, and at the time at which, it has been so applied.

….

(5) Where, by reason of an amendment of a determination made under this Division, the amount, or the sum of the amounts, applied or paid by the Commissioner as a credit to which a person is entitled exceeds the amount of the credit to which that person is entitled, the Commissioner may recover the amount of the excess as if it were Australian tax due and payable by that person."

His Honour noted that s 160AN(5) did not deem the excess referred to therein to be "tax".

72. It is quite apparent from the primary Judge's reasons that his Honour did not have benefit of the Commissioner's now argument that the effect of the amended determination was to increase, nunc pro tunc as it were, the tax that CPL was "liable to pay", as distinct from increasing the tax as assessed. On appeal, CPL's response to that argument relied on the operation of subs (3) of s 160AN. It was asserted - without demur being heard from the Commissioner - that, when CPL claimed the foreign tax credits in question, the Commissioner applied those credits in discharge of CPL's liability to the Commonwealth, upon which event CPL was deemed to have paid the tax against which the credits were applied. If that were so, according to CPL's argument, CPL had paid the tax, and it could not be said that the tax "remain[ed] unpaid" within the meaning of s 204(3), even after the amendment of the relevant foreign tax credit determinations. The Commissioner's remedy, in such a case, lay in subs (5) of s 160AN, which entitled him to recover the amount of the excess "as if it were … tax due and payable", but did not deem the excess to be tax.

73. As a matter of construction, we consider that CPL's argument must be accepted. It proceeds from an acceptance of the Commissioner's propositions that the amendment of a foreign tax credit determination would have an impact on the tax that a taxpayer was "liable to pay" within the meaning of s 204(3) and that there would then be, retrospectively as it were, an amount of tax that remained unpaid, but it brings in s 160AN(3) to produce the result that that amount had in fact been paid. The recovery provisions of s 160AN(5) support this construction, leaving no necessity for the reversal of the effect of subs (3). That is to say, the statutory scheme seems to be such that, upon the application of a credit to a tax liability, the tax is deemed to have been paid. The later amendment of the relevant determination does not affect that, but the excess may be recovered under subs (5).

74. The Commissioner's first response to this submission on behalf of CPL was to say that s 160AN(3) had nothing to do with the facts of the present case. He said that, when it lodged its tax returns for the 2003 and 2004 years, CPL did so conformably with s 4-10(3) of the 1997 Act, which provided:

"(3) Work out your income tax for the financial year as follows:

Income tax = (Taxable income × Rate) − Tax offsets

Method statement

Step 1. Work out your taxable income for the income year.
To do this, see section 4-15.

Step 2. Work out your basic income tax liability on your taxable income using:

(a) the income tax rate or rates that apply to you for the income year; and

(b) any special provisions that apply to working out that liability.
See the Income Tax Rates Act 1986 and section 4-25.

Step 3. Work out your tax offsets for the income year. A tax offset reduces the amount of income tax you have to pay.
For the list of tax offsets, see section 13-1.

Step 4. Subtract your tax offsets from your basic income tax liability. The result is how much income tax you owe for the financial year."

A foreign tax credit was an "offset" within the meaning of this provision. Accordingly, so the argument ran, an offset was something which reduced a taxpayer's "income tax"; and the reversal of a claimed, and previously-allowed, offset necessarily had the effect of increasing the tax.

75. We are not persuaded that the very high-level provisions of s 4-10 of the 1997 Act have the effect of rendering the otherwise applicable specific provisions of s 160AN irrelevant to the circumstances of a taxpayer who claims a foreign tax credit. We were not addressed on the provisions of Div 3 of Pt IIB of the Administration Act, but they do appear to impose mandatory obligations on the Commissioner in any case in which a taxpayer claims a credit; and we note that the Commissioner did not submit that they were not observed in the present case. As against those specific provisions, which are quite precise in their treatment of credits, s 4-10 merely informs the taxpayer how to work out his or her income tax. It should not be read, in our view, to qualify what would otherwise be the effect of s 160AN(3). We would add that we do not think it does have that effect, as properly construed. In a situation in which the Commissioner is bound to apply credits in discharge of what would otherwise be a tax liability, and does so, the simple equation in s 4-10 strikes us as being an accurate way of stating the effect of the law, albeit one which is appropriately robust in the statutory setting in which it is to be found.

76. The Commissioner next submitted that, if CPL's argument were sound, it would leave the 1936 Act making no provision for the payment of interest by a taxpayer whose claimed credits were later reversed. It could not have been intended by the legislature to extend an interest-free loan to a taxpayer in such circumstances, particularly in the light of the policy so evident in s 204(3) itself. At the general level, there is force in this submission. If the terms of the statute were such as fairly to allow an interpretation which would give s 204(3) an operation in the case of an amended foreign tax credits determination, the considerations to which the Commissioner referred might well tip the scales towards the construction for which he contends. However, the legislation as it stood at the relevant time, and the legislative history prior to that, tend rather to tip the scales the other way.

77. Before certain amendments to the 1936 Act in 1999 and 2000 to which we shall turn, subs (1) and (1A) of s 170AA provided as follows:

"(1) Subject to this section, where an amendment of an assessment increasing the liability of a taxpayer to tax is made, the taxpayer is liable to pay interest to the Commissioner, calculated in accordance with subsection (4), on the amount (in this section referred to as the principal amount) by which the tax payable by the taxpayer under the amended assessment exceeds the tax payable by the taxpayer under the assessment that was amended.

(1A) Subject to this section, where an amendment of a determination reducing a credit, or an offset within the meaning of Part IIIAA, allowable to a taxpayer is made, the taxpayer is liable to pay interest to the Commissioner, calculated in accordance with subsection (4), on the amount (in this section also called the principal amount) by which the amount of the credit or offset allowable to the taxpayer under the amended determination is less than the amount of the credit or offset allowable to the taxpayer under the determination that was amended."

Section 204 contained no provision of relevance to the present matter of interest.

78.The Taxation Laws Amendment Act (No 3) 1999 (Cth) introduced the concept, and provisions for the operation, of the general interest charge into the 1936 Act. Subsections (1) and (1A) of s 170AA were amended to substitute, in each case, the expression "the general interest charge, for each day in the period in subsection (4)" for the expression "interest to the Commissioner, calculated in accordance with subsection (4)". Subsection (3) was added to s 204, as follows:

"If any of the tax which a person is liable to pay remains unpaid after the time by which the tax is due to be paid, the person is liable to pay the general interest charge on the unpaid amount for each day in the period that:

(a) started at the beginning of the day by which the tax was due to be paid; and

(b) finishes at the end of the last day on which, at the end of the day, any of the following remains unpaid:

(i) the tax;

(ii) general interest charge on any of the tax."

79. The result of these amendments was that s 204(3) imposed a liability to pay the general interest charge on unpaid tax and s 170AA imposed the general interest charge in circumstances where an amendment to an assessment (subs (1)), or to a credit/offset determination (subs (1A)), was made. As a matter of construction, there could be no suggestion that the legislature contemplated that s 204 would provide for circumstances in which liability to pay the general interest charge would arise in the latter situations.

80. Further amendments were made by the A New Tax System (Taxation Administration) Act 1999 (Cth), but the only one of any real relevance to the present issue was the introduction of subs (1A) into s 204.

81. The A New Tax System (Taxation Administration) Act (No 2) 2000 (Cth) introduced a new Div 284 into Sched 1 of the Administration Act. That dealt with the subject of penalties. To the extent presently relevant, the amendment did not deal in terms with the general interest charge. However, in a schedule to the Amendment Act headed "Consequential and miscellaneous amendments", the following new subs (15) was added to s 170AA:

"This section does not apply to amendments relating to the 2000 01 year of income or a later year of income."

The result of this was that s 170AA(1A) had no application to the circumstances which have become controversial in the present case.

82. The Commissioner submitted that the result of this amendment of 2000 was to transfer to s 204(3) the matter of general interest charge in the context of an amended foreign tax credits determination. It did no such thing in terms, of course, but the Commissioner relied upon the following passage in the Explanatory Memorandum for the amending Bill:

"For taxpayers who do not lodge on time, the due date is 21 days after the date specified in the Gazette …. This due date will also apply to tax due under amended assessments for those taxpayers. The GIC which is calculated under section 170AA of the ITAA 1936 where an assessment is amended increasing the taxpayer's liability will no longer apply. Instead, GIC will be calculated under subsection 204(3) from the statutory due date. The due date for tax payable under amended assessments where the return is lodged on time is the date explained in paragraph 1.182."

It seems tolerably clear from this that it was the draftsman's view that the effect of the new s 170AA(15) was to leave s 204(3) to do the work previously done by s 170AA itself, save that, as indicated in the memorandum, the general interest charge would now be calculated from the original due date, rather than from the date of the amendment.

83. In our opinion, the Commissioner's submission seeks to place a greater constructional load on the Explanatory Memorandum than it can reasonably bear. The 2000 amendments dealt with the subject of the general interest charge in a very sweeping way. They rendered thenceforth inoperative two subsections which, as properly construed, dealt with different things - an increased tax liability and the reduction of a credit or offset previously allowed. But those subsections, and the distinction which they made, remained in the 1936 Act. In terms, s 204(3) dealt with tax liability only, and, as such, appeared not to be concerned with subs (1A) of s 170AA.

84. Specifically in the context of the present case, if, as we consider to be so, CPL's reliance on s 160AN(3) is sound, it must be said that the Explanatory Memorandum was quite unconcerned with that dimension of the problem. There was no suggestion that the draftsman had ever turned his or her mind to the prospect that s 160AN(3) might so operate as to deem tax to have been paid when a foreign tax credit, as claimed, was applied to a tax liability. Quite what the legislature would have done if the relationship between s 160AN and 204(3) had been raised at the time of the insertion of s 170AA(15) is a legitimate question to which the Explanatory Memorandum supplied no answer.

85. We would add only that the present is not in the category of case in which an obvious drafting error has been made, but the legislature's intention is manifest: see
Cooper Brookes (Wollongong) Pty Ltd v Commissioner of Taxation 81 ATC 4292; (1981) 147 CLR 297. Rather, this is within that class of case in which the terms of the legislation and of the Explanatory Memorandum provide grounds to suppose that the legislature thought it was doing something, but that thing was not in fact done by the amending Act of 2000. Particularly apropos the operation of s 160AN(3), this might be a case in which the legislature simply overlooked a relevant dimension of the problem with which it was dealing. For us now to hold that that subsection did not, after 2000, have the effect conveyed by its terms would be, in our view, to engage in judicial legislation. It is not a course we should follow.

86. We consider that the primary Judge was correct in his conclusion that s 204(3) did not impose the general interest charge in the facts of the present case. The Commissioner's appeal should be dismissed. We shall take the same approach to the matter of costs as mentioned in para 69 above in the context of CPL's appeal.

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Foreign Income Analysis
Year	0	1	2	3	4	5
Foreign Source Income		13.658.537	13,658,537	13,658,537	13,658,537	13,658,537
Less Foreign Deductions		0	0	0	0	0
Net Foreign Source Income		13,658,537	13,658,537	13,658,537	13,658,537	13,658,537
Australian Tax Payable (30%)		4,097,561	4,097,561	4,097,561	4,097,561	4,097,561
Less Foreign Tax Credits		-4,097,561	-4,097,561	-3,756,098	0	0
Net Australian Tax Payable	0	0	0	341,463	4,097,561	4,097,561
FTC carried forward	11,951,220	7,853,659	3,756,098	0	0	0