The Federal Court has recently delivered an important decision about the application of the general anti-avoidance provisions under Part IVA of the Income Tax Assessment Act 1936 (1936 Act). In particular it is a decision about how the Commissioner assesses facts and frames his arguments about tax-driven schemes.
Justice Gordon’s judgment in Star City Pty Limited v Commissioner of Taxation [2007] FCA 1701 should give the Commissioner cause to consider the manner in which he views commercial transactions and identifies both tax benefits and schemes for the purpose of the 1936 Act. Her Honour was critical of the Commissioner’s attempts to selectively rely on facts and documents and made clear that transactions need to be considered fully, objectively and in context.
Parties in dispute with the Commissioner in relation to potential or existing Part IVA determinations should closely consider this judgment and its implications. It may provide a basis to invite the Commissioner to re-evaluate his Part IVA conclusions.
The dispute
Star City Pty Limited (Star City) was awarded a licence in 1994 by the Casino Control Authority of New South Wales (CCA) to operate a casino in Sydney. A separate lease agreement for both a temporary and a permanent casino site was executed contemporaneously by a separate company, Sydney Harbour Casino Properties Pty Limited (SHCP).
SHCP and Star City entered a licence agreement, also contemporaneously, by which Star City was given a non-exclusive licence to the casino premises. Under the licence agreement Star City took on the obligation to pay all rent due under the lease. Both Star City and SHCP were wholly owned subsidiaries of Sydney Harbour Casino Holdings Pty Ltd (Holdings). The lease was granted by the New South Wales government for 99 years on a parcel of Crown land.
A term of the lease was that the rent for the first 12 years of the lease in the amount of $120 million would be prepaid (the Prepayment). The Prepayment was made by Holdings within the time prescribed by the lease.
Star City claimed the Prepayment of rent as a deduction and apportioned it pursuant to s 82KZM of the 1936 Act. The Commissioner disallowed deductions claimed in the 1995 to 2002 income years and imposed penalties.
Four issues arose in the dispute:
- Was the Prepayment of rent an obligation of Star City’s or, as the Commissioner contended, an obligation of SHCP?
- Was the Prepayment an outgoing incurred by Star City pursuant to s 51(1) of the 1936 Act and/or s 8-1 of the Income Tax Assessment Act 1997 (1997 Act)?
- If yes to Issue 2, was the Prepayment an outgoing of capital or of a capital nature?
- If yes to Issue 2, and no to Issue 3, did Part IVA operate to disallow the deduction?
Her Honour found for the taxpayer, holding that the Prepayment was deductible, that it was not an outgoing of capital or of a capital nature, and that Part IVA did not apply.
Determining facts
While the Court’s findings in relation to Part IVA are of particular interest, its findings in relation to the Commissioner’s treatment of factual matters are equally important.
At paragraph 10 of the judgment her Honour says in part:
"The documents referred to by the Commissioner (and the facts said to be established by them) are incomplete and inaccurate because they were merely part of the Bid Process and, even then, a disconnected and disjointed part. The conclusions or inferences the Commissioner would have the Court draw were not open because, when viewed objectively, the Bid Process was very different from that which the Commissioner submitted it to be. The documents and facts referred to by the Commissioner had been taken out of context and, viewed objectively, did not lead to the conclusions contended for by the Commissioner."
Note: The Bid Process referred to comprised the entire process for the granting of a casino licence commencing with the issue of an invitation for expressions of interest. That process lasted over 9 months and involved numerous parties. It is described in detail in a 32-page annexure to the judgment.
What is clear from this passage is that it is necessary for the Commissioner to have regard to the full factual matrix regarding a particular transaction, not just to those elements which can be couched in terms of a tax-driven scheme. Taxpayers and advisers should not be reticent about ensuring that the Commissioner takes account of all relevant factual matters.
The Commissioner attempted to portray the obligation to pay rent under the licence agreement as an obligation belonging to SHCP, rather than Star City. To this end it relied on a particular interpretation of a single clause in the licence agreement.
The Court rejected the Commissioner’s approach saying the clause could not be read in isolation. It was necessary to read and take account of the whole licence agreement along with the other contemporaneous transaction documents.
It went on to expressly reject the Commissioner’s interpretation of the relevant clause, saying that the Commissioner’s interpretation "is inconsistent with the terms of the [licence] read as a whole and the other agreement executed contemporaneously, lacks commercial reality and, no less importantly, would leave cl. 5.2 of the [licence] with no work to do."
The Court’s acknowledgement of the validity of considerations of commercial reality should be heartening for advisers, as it is a matter which seems not always to be recognised by the Commissioner. Further references to the legitimacy of commercial considerations include "… each side of the negotiation (unsurprisingly) sought to obtain the best commercial result it could." and "It goes without saying that any rational economic actor will endeavour to minimize the tax consequences of a business transaction."
The Court also rejected the Commissioner’s attempt to rely upon the conduct of the parties to support his contention about the proper construction of the payment of rent clause in the licence. After holding that this material was not relevant, the Court comprehensively dismissed the Commissioner’s interpretations of various non-transactional documents. By way of example, the Commissioner contended that a letter from Star City to the Treasurer of New South Wales supported its view that SHCP was liable to pay rent, rather than Star City. The Court held that this letter was entirely irrelevant since it was not a communication between the parties to the licence and did not and could not provide evidence of the objective factual background known to the parties at the relevant time.
Part IVA
Identifying the scheme
The Commissioner nominated two schemes within the meaning of s 177A of the 1936 Act being a wide scheme and a narrow scheme. The schemes were the same except the narrow scheme omitted one step contained in the wide scheme.
Star City conceded that the schemes identified by the Commissioner were capable of being schemes for the purpose of Part IVA, no doubt in light of the broad definition of a scheme contained in the Act, but her Honour held that neither of the identified schemes was a scheme for the purpose of s 177A.
Each scheme was described as "…no more than an incomplete and inaccurate historical record of some of the events which occurred in a period spanning some 9 months; it is at best, a series of disjointed and unconnected steps."
These comments will be useful in future cases where the Commissioner is considering complex transactions and/or transactions spanning periods of time, and he attempts to cherry-pick particular documents to support his view that Part IVA should apply.
Where the Commissioner has identified a scheme comprising a number of steps or multiple actions, he must be able to show a connection between those actions. A scheme cannot be identified by "abstracting bits from what actually happened." Further, the steps can only constitute a single scheme, and that scheme must exist from the outset.
In the present case, her Honour held that the identified schemes simply did not exist as a matter of fact. She referred to the factual deficiencies in the Commissioner’s arguments and found that the identification of both schemes ignored the objective facts. The dominant (and commercial) purpose of the CCA (and the New South Wales government) was to maximize the amount of money to be paid for the casino licence. The dominant (and commercial) purpose of Star City and its related entities was to obtain the casino licence. The Commissioner’s position ignored two key facts that had existed from the outset: that the casino would operate on leased Crown land and that rent would be paid.
Determining the tax benefit
The Court also held that Star City did not obtain a "tax benefit" as defined by s 177C of the 1936 Act. It rejected the Commissioner’s "alternative postulate" (or "counterfactual"), finding that it was not something which might reasonably be expected to have happened if the scheme had not been entered into or carried out.
The alternative postulate identified by the Commissioner relied upon a number of events arising in the bid process, but the Court found that this approach was inaccurate and failed to reflect the factual realities of what had occurred during the process. Assessing whether a tax benefit was obtained and whether the taxpayer had a dominant purpose of obtaining a tax benefit required an objective consideration of the relevant facts of the matter.
It is necessary for the Commissioner to put forward a reasonable alternative postulate. He must demonstrate that the taxpayer could have structured the alternative as postulated by the Commissioner, and that the other parties to the transaction would have accepted that alternative. In the absence of satisfying these conditions, it will not be possible to say that it was reasonable to expect the alternative postulate to have occurred.
For taxpayers and advisers, what this suggests is that close scrutiny needs to be given to the alternative put forward by the Commissioner to ensure that it is a valid proposition based on an objective analysis of the facts as they were at the time, rather than a proposition based on what the Commissioner thinks should have been done with the benefit of hindsight.
The s 177D(b) factors
Her Honour did not consider in detail the eight factors under s 177D(b) of the 1936 Act as a consequence of her findings that there was no scheme and no tax benefit, though she reaffirmed that the test of purpose is an objective test, and referred to the High Court’s comments in FCT v Hart (2004) 217 CLR 216 that the bare fact of a taxpayer paying less tax from using a particular form of transaction does not show that Part IVA applies.
The provision of tax advice
While not a central aspect of this judgment, the Court noted that it is not surprising that taxation considerations were taken into account by Star City. Her Honour says "It would be surprising, if not negligent of [Star City and its related entities], if they did not [refer to taxation considerations]."
It is encouraging to see the Court recognising that taxation consequences are an important and legitimate aspect of conducting business transactions and that it is proper for parties to take those matters into account, particularly in circumstances where the Commissioner may be suggesting that any consideration of taxation consequences demonstrates a tax-driven dominant purpose.
Was the Prepayment an outgoing of capital or revenue?
The Court held that the Prepayment was a revenue outgoing and was not an outgoing of capital or of a capital nature. It applied a traditional analysis of this question to the facts of the case in reaching its decision, finding that the character of the advantage sought was to secure the use of the casino premises for generating income.
Again the Court rejected the Commissioner’s attempts to rely on selective facts and interpretation of documents. It found that on the objectively determined facts it was clear that the rental payments made by the Prepayment were revenue outgoings, and the fact that they were prepaid did not change that character.
Status of decision
The Court’s judgment was delivered on 9 November 2007 and the parties were invited to make submissions about appropriate orders. The parties were due in Court on 16 November 2007 to make those submissions. At the time of writing this article orders had not been made by the Court, but they should be published shortly along with the reasons for judgment.
For further information, please contact your usual PricewaterhouseCoopers adviser or:
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Michael Bersten, Partner
PricewaterhouseCoopers Legal
Tax Controversy
Tel +61 2 8266 6858 |
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Edwina McLachlan, Director
PricewaterhouseCoopers Legal
Legal
Tel +61 2 8266 4930 |
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