The decision in Macquarie Bank Limited v Commissioner of
Taxation [2011] FCA 1076 clarifies the operation of Part IVA
of the Income Tax Assessment Act 1936
(Act) as it applies to subsidiary members of
consolidated groups.
Facts of the case
An Australian resident company (Taxpayer),
being a wholly owned subsidiary of a Delaware limited liability
company (Delaware LLC), commenced an on-market
takeover bid for all the issued shares of the listed entity, Minara
Resources Limited (previously known as Anaconda Nickel Limited).
The Delaware LLC was a member of the MatlinPatterson Group, a US
based private equity firm. The target's majority shareholder
(Glencore International AC) rejected the takeover offer, resulting
in the Taxpayer only acquiring 36% of the target company's shares.
The Taxpayer retained the target's shares for an extended period
and their value increased substantially during that time, producing
a profit in excess of $317m. Macquarie Group approached
MatlinPatterson and sought their agreement to act as the Taxpayer's
agent to dispose of their interest in the target. The agency
arrangement did not eventuate.
Subsequently, Macquarie Group agreed to acquire
MatlinPatterson's interests in Delaware LLC for $122m. Macquarie
Group also agreed to lend Delaware LLC $317m, which it then
distributed to its shareholders as capital profits. This reflected
the underlying increase in the target's shares, which its
subsidiary owned. In all, the Delaware LLC shareholders received
back their initial investment plus the profit of $277m they made
during the holding period.
Macquarie Group is a consolidated group pursuant to the
Income Tax Assessment Act 1997 (1997
Act), with Macquarie Bank Limited (MBL)
as the head company. When Macquarie Group acquired Delaware LLC,
its original directors (and those of the Taxpayer) were replaced
with MBL nominees who were residents of Australia. For tax
purposes, Delaware LLC became an Australian resident. Also,
Delaware LLC (and the Taxpayer) automatically became subsidiary
members of the Macquarie consolidated group. After this event the
Taxpayer then sold its interest in the target. The tax
consolidation regime provides that the tax attributes of
subsidiaries are assumed by the head company and the group is
deemed for tax purposes to be one entity.
The structure of the transaction meant that Macquarie Group
underwrote MatlinPatterson's profit, and Macquarie Group also
assumed the commercial risks of selling the target's shares. For
these reasons, MatlinPatterson was prepared to share with Macquarie
Group some of the profit they otherwise would have earned from the
sale of the target's shares. Further, the transaction's structure
(which Macquarie Group devised) resulted in the proceeds derived by
the vendors of Delaware LLC shares not being subject to Australian
tax, because it was a sale by non residents of their respective
interests in a non resident company.
MBL, as the head company, included in its assessable income a
$40m gain on the transaction, which was substantially greater than
what it would have earned if it acted solely as the Taxpayer's
agent. This was the amount of profit MatlinPatterson was prepared
to share with Macquarie Group.
The Commissioner made two determinations pursuant to section
177F(1)(a) of the Act. In consequence of the determinations he then
issued amended assessments to each of the Taxpayer and MBL. The
assessments included in each entities' assessable income a
purported tax benefit equal to the gain the Taxpayer would have
made, had it sold its investment in the target before becoming a
subsidiary member of the Macquarie consolidated group.
Issues
The Commissioner contended that Part IVA of the Act applied. The
court noted that the Commissioner's grievance was that the parties
availed themselves of the Consolidated Group provisions of Pt 3- 90
of the 1997 Act. In particular, the express provision of the
legislation that where a subsidiary member joins a consolidated
group, and subsequently disposes of an asset, the subsidiary member
is not taxed on the difference between the proceeds and the cost
(the profit actually or 'in fact' made by the subsidiary), because
of the operation of section 701-1 of the 1997 Act, while the head
company is taxed not on the profit 'in fact' made by the
subsidiary, but on the economic profit made by the head company
(the cost to the head company of the acquisition of the subsidiary
is pushed down to become the tax cost setting amount of the asset
disposed of by the subsidiary (Div 705)), thus avoiding tax on a
substantial portion of the gain on the sale of the target's shares.
The Commissioner argued that in the context of the transaction, the
result was not a purpose that was consistent with the objects of Pt
3-90 as set out in section 700-10 of the 1997 Act.
The Commissioner submitted that the acquisition of Delaware LLC
by Macquarie Group (with the effect that it became a subsidiary
member of a consolidated group), the provision of the loan, the
change of directors and the subsequent sale by the Taxpayer of the
target's shares, was a scheme. The parties to the scheme included
MBL, Delaware LLC, the Taxpayer and the vendors of Delaware LLC.
The scheme produced a tax benefit to the Taxpayer of around $318m.
(This conveniently ignores the fact that Macquarie Group acquired
the Taxpayer's holding company (Delaware LLC) for $440m and if this
entity had been an Australian resident company, it would have paid
tax on any gain.) It was the non resident status of Delaware LLC
that is at the heart of this issue.
The Commissioner's counterfactual submission was that, but for
the scheme, the Taxpayer would have sold the shares or might
reasonably have been expected to have sold the shares in its own
right. It would not have sold the shares as a subsidiary member of
the Macquarie consolidated group and it would have included the
profit (the tax benefit) in its assessable income - which, due to
the scheme, was derived in a tax free form by the vendors of
Delaware LLC. In the alternative, the Commissioner claimed that MBL
had derived the tax benefit in consequence of the scheme.
Decision
The court rejected the Commissioner's arguments. It held that
the Commissioner's counterfactual submission (that is, but for the
scheme, it could reasonably have been expected that the Taxpayer
would not be part of the consolidated group and the
Taxpayer would have derived the profit, including it in its
assessable income) had the consequence that MBL could never obtain
the tax benefit. Therefore, the determination made pursuant to
sections 177F(1)(a) & (2) of the Act that MBL had obtained a
tax benefit was incorrect.
The court then considered the Commissioner's additional
arguments - that he could make a determination, and then raise an
amended assessment against the Taxpayer. Alternatively, in raising
an amended assessment against MBL, the Commissioner submitted that
he was thereby 'giving effect' to his determination that the
Taxpayer had derived a tax benefit. Relevant to these matters was
whether the operation of the consolidation rules resulted in the
Taxpayer not being a 'taxpayer', as that term is
defined in section 6(1) of the Act. Also, did section 177F allow
the Commissioner to make a determination to include a tax benefit
as assessable income of a subsidiary member of a consolidated
group?
In the present case, the court believed that a determination
could be made. However, the court focused on the 'next level' of
giving effect to the determination, which can only be achieved by
issuing an amended assessment. On this point the court found that,
on the facts of the case, it was unlawful for the Commissioner to
issue an amended assessment to the Taxpayer, because it was a
subsidiary member of the Macquarie consolidated group and, as such,
is not a separate entity liable to tax under those provisions.
The court found that Part IVA does not authorise the
Commissioner to issue an assessment including an amount in the
assessable income of a subsidiary member of a consolidated group.
The Commissioner's section 177F power to take 'such action as he
considers necessary', is not at large. It is limited to action that
gives effect to a determination. A determination under section 177F
only informs the calculation of a taxpayer's assessable income on a
particular hypothesis; it does not and cannot
authorise the exclusion of a company from a
consolidated group in fact, so as to constitute it an entity liable
to tax, nor authorise the Commissioner to disregard section 701-1
and section 701-30 of the 1997 Act and assess the subsidiary member
in disregard of those provisions. To do so, the relevant provisions
of Part IVA must grant to the Commissioner specifically the power,
which they do not.
In respect to the issuing of an amended assessment to MBL to
give effect to the Commissioner's section 177F determination, the
court held that this position assumed that the Commissioner can
issue an assessment to a different taxpayer to the taxpayer the
subject of the determination. While accepting that in some limited
circumstances this may be possible (for example, making a
determination that a tax benefit arises where a trustee omits
income and thereby the Commissioner issues an assessment to a
beneficiary), the present case was not such a circumstance. The
court again held that regard must be had to the counterfactual
submission on which the Commissioner's case was founded. It decided
that, to give effect to an anterior determination to include an
amount in the assessable income of a taxpayer, it must be factually
consistent with the hypothesis upon which that determination is
predicated, whether the assessment is issued to the taxpayer
referred to in the determination or a different taxpayer. The MBL
amended assessment was not factually consistent with the hypothesis
upon which the Taxpayer determination was predicated - that the
Taxpayer sold the target shares otherwise than as a subsidiary
member of the Macquarie consolidated group - therefore it follows
that the MBL amended assessment could not and did not give effect
to the Commissioner's determination. Accordingly the appeals were
allowed.
Further issues
The court, at the request of the parties, also agreed to
consider and determine two further issues, because they may be
relevant matters in the event appeal proceedings are initiated.
This was on the understanding that it only related to the
Commissioner's contention that issuing an amended assessment to MBL
gave effect to the determination made in respect of the
Taxpayer.
The additional issues involved whether:
- the Taxpayer did obtain the alleged tax benefit in connection
with the scheme identified by the Commissioner; and if so,
whether,
- any one or more of the parties identified as having entered
into or carried out the scheme, or any part of the scheme, did so,
having regard to the eight factors in section 177D(b) of the Act,
for the dominant purpose of enabling the Taxpayer to obtain a tax
benefit.
The court concluded that the Taxpayer had obtained a tax benefit
in that, but for the scheme, the Taxpayer would not have become a
member of a consolidated group and would have or could reasonably
have been expected to have sold the target's shares (under the
agency agreement) and included the gain in its assessable income.
There was no other course of action that was at that time
being pursued by the Taxpayer.
In relation to the dominant purpose issue, the court concluded
that, having regard to the eight items in section 177D(b), each of
the parties to the scheme did not enter into the scheme with the
dominant purpose of enabling the Taxpayer to obtain a tax
benefit.
Conclusion
The Commissioner's position is commercial illogical. Clearly
Macquarie paid virtually full market value for Delaware LLC and its
Australian subsidiary. From Macquarie Group's perspective, the tax
payable should therefore be limited to the gain made in excess of
the cost base derived on disposing of the target's shares. However,
the Commissioner seems incensed by the fact that non residents
escaped paying tax on the gain they obtained from the disposal of
their Australian assets owned through a chain of entities, some of
which were non residents.
The Commissioner's approach may form part of a strategy to deal
with some private equity transactions that are structured in the
manner adopted by MatlinPatterson. However, due to the technical
architecture dealing with members of consolidated groups, under
current legislation, subsidiary members cannot be subject to tax.
The position in relation to groups that are not consolidated,
therefore, might be more problematic. Each entity could be the
subject of a separate determination, given the approach the court
adopted in the case. It suggests that entities forming part of an
Australian unconsolidated group may need to consider forming a
consolidated group before a transaction, in the nature considered
by the court, is undertaken.