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Focus: Three into Part IVA ain't bad

25 August 2010

In brief: While the decisions in three recent Federal Court cases deliver mixed results for taxpayers, they offer guidance on the application of Part IVA of the Income Tax Assessment Act 1936 (Cth). The Citigroup case is particularly relevant to multinationals and finance entities. Partners Charles Armitage (view CV) and Malcolm Stephens (view CV) and Senior Associate Chris Peadon report.

How does it affect you?

  • The three decisions are a reminder that consideration of Part IVA requires a detailed investigation of the facts in each case.
  • The decision in Citigroup indicates that it may be important for the purposes of Part IVA to consider whether, without the disputed tax benefit, the transaction would result in a post-tax profit.
  • News Australia Holdings' success in the Full Federal Court confirms that Part IVA will not apply merely because a corporate restructure is carried out in a manner that creates certain, rather than uncertain, tax consequences.
  • The decision in Trail Bros emphasises the importance of taxpayers adducing adequate evidence to discharge their burden of proof.

Introduction

In general terms, Part IVA of the Income Tax Assessment Act 1936 (Cth) applies to transactions entered into for the dominant purpose of obtaining a tax benefit. The dominant purpose is determined by reference to eight specified objective factors, rather than subjective intention. If Part IVA applies, the Commissioner may cancel all or part of the tax benefit.

The three decisions discussed below give guidance to taxpayers in relation to matters indicating that Part IVA may apply.

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Citigroup Hong Kong bonding

The Citigroup case1 is perhaps most interesting for entities considering highly structured financing transactions. It concerned 1998 amendments to Part IVA that extended the operation of the Part to schemes designed to acquire or generate foreign tax credits that could be used to shelter low-taxed foreign-sourced income from Australian tax.2

The case concerned two transactions involving a subscription for bonds issued in Hong Kong, and the subsequent sale of the interest and principal entitlements under the bonds. The transactions had an 'aura of complexity' that was largely due to the parties following the Hong Kong Guidelines in relation to the 'ordinary' manner in which such schemes are carried out in that jurisdiction and was not taken as indicating that Part IVA should apply.

The taxpayer said the transactions did not exhibit any of the elements identified in the extrinsic materials to the 1998 amendments to Part IVA.3 The taxpayer also suggested that, despite the potentially broad application of the provision, it should be construed narrowly and confined to the transactions given as examples in the extrinsic materials.4 The court rejected that contention and held that examples in extrinsic materials cannot be used to alter the plain words of the legislation.

The taxpayer also suggested that Part IVA had no application 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'.5 The court rejected this argument on the basis that favourable tax outcomes could be created by taking advantage of different tax rates and different methods for calculating assessable income.6

In this particular case, the two principal factors that Justice Edmonds identified as suggesting that the dominant purpose of the scheme was to obtain a tax benefit (ie the foreign tax credits) were:

  • the choice of the taxpayer as principal partner in the Hong Kong Bond Purchasing Partnership on the basis of the Australian foreign tax credit regime – ie the selection of an Australian entity rather than, eg, a Hong Kong entity was only explicable on this basis;7 and
  • perhaps of more general interest, the fact that the transactions resulted in a post-tax loss if the tax benefit were excluded. In relation to the first transaction, the pre-tax profit of $14.3 million was reduced to a post-tax loss of $1.5 million if the foreign tax credits were not taken into account.8

In light of the above, Justice Edmonds dismissed the taxpayer's applications.

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The 'no tax, no tax risk' policy

News Australia Holdings Pty Ltd v FCT9 concerned a substantial capital loss arising out of the reincorporation of the News Group in the United States.

The reincorporation could have been carried out in a number of different ways. One of these might, depending on movements in exchange rates, have resulted in tax liabilities in excess of $20 billion for the News Group. The News Group therefore effected the transaction in a manner that avoided this risk. This decision was consistent with a group policy of not entering into restructuring transactions that gave rise to a tax liability or the risk of a tax liability (the 'no tax, no tax risk' policy).

The Commissioner of Taxation applied Part IVA to deny the News Group the ability to use the capital losses arising from the restructure. The Administrative Appeals Tribunal (the AAT) set aside this decision, and the Commissioner appealed to the Full Federal Court.

The Commissioner alleged that the AAT had impermissibly taken the taxpayer's subjective intention (ie the 'no tax, no tax risk' policy) into account in determining objectively, by reference to the eight factors outlined in Part IVA, whether the dominant purpose of entering into the transaction was to obtain a tax benefit.

The Full Federal Court agreed that it would have been impermissible for the AAT to take into account the subjective intention of the taxpayer, but held that it had not done so. The Full Court noted that 'it is hardly surprising if objective intention in fact accords with the person's subjective intention'.

The Full Court therefore did not need to determine a separate issue, which was whether the a taxpayer's subjective purpose might be taken into account in determining the 'alternative postulate'. This issue was touched on in the next case considered in this Focus.

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Countering the 'counterfactual'

In FCT v Trail Bros Steel and Plastics Pty Ltd,10 an issue arose as to which party had the onus of proof in relation to the 'counterfactual' or 'alternate postulate' that section 177C requires in order to determine whether a 'tax benefit' was obtained. For example, if:

  • a taxpayer enters into a 'scheme' for the purpose of obtaining a deduction of $100; but
  • the court is satisfied that, had it not entered into the scheme (the 'alternate postulate'), it would legitimately have obtained a deduction of $100 by other means,

then the taxpayer has not obtained a 'tax benefit'. If, on the other hand, the taxpayer would have taken steps that would have resulted in no deduction (or another less advantageous tax outcome), then it has obtained a tax benefit.

The taxpayer's case was that it would have taken unspecified steps to obtain a deduction equal to the deduction that had been disallowed. It had, however, adduced no evidence of what those steps might be. The taxpayer said it was for the Commissioner to establish that the taxpayer would have taken the steps the Commissioner outlined in his counterfactual.

The Full Federal Court rejected the taxpayer's submissions and held that the onus was on the taxpayer to prove the 'alternate postulate'.

The court also commented on the extent to which 'subjective purpose' might be relevant in determining the alternate postulate. It held that evidence from the taxpayer 'of what he or she would have done but for entering the scheme... will be relevant and useful to the extent to which it reveals facts or matters that bear upon the objective determination of the alternative postulate'.11 As shown by this statement, the interaction between 'objective purpose' and 'subjective purpose' can be very complex, and is likely to be the subject of further consideration by the courts over the next few years.

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Status of proceedings

At the time of writing the time for the taxpayer to file a notice of appeal to the Full Federal Court from the Citigroup decision had not expired (the taxpayer has until 30 August 2010 to do so). The time for the taxpayer in Trail Bros to file an application for special leave to appeal that decision to the High Court does not expire until 27 August 2010. It may be that these decisions will be subject to an appeal. The decision in News is final and there will be no appeal.

Footnotes
  1. Citigroup Pty Limited v FCT [2010] FCA 826.
  2. At [8].
  3. At [19].
  4. At [20].
  5. At [17].
  6. At [18].
  7. At [134].
  8. At [144].
  9. FCT v News Australia Holdings Pty Ltd [2010] FCAFC 78
  10. FCT v Trail Bros Steel and Plastics Pty Ltd [2010] FCAFC 94.
  11. At [36].

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