Federal Commissioner of Taxation v AXA Asia Pacific Holdings Ltd

FEDERAL COURT OF AUSTRALIA

Federal Commissioner of Taxation v AXA Asia Pacific Holdings Ltd

[2010] FCAFC 134

Dowsett, Edmonds and Gordon JJ

17-19 May, 18 November 2010 – Melbourne

Capital gains tax — Scrip-for-scrip roll-over relief under — Whether the parties to the transaction dealt with each other “at arms length” — Pt IVA of the Income Tax Assessment Act 1936 (Cth) — Whether the respondent obtained a “tax benefit” in connection with the scheme — Identification of the alternative postulate — Income Tax Assessment Act 1997 (Cth), Subdiv 124-M — Income Tax Assessment Act 1936 (Cth), Pt IVA.

Under a leveraged buy-out arrangement organised by Macquarie Bank Ltd, the taxpayer’s subsidiary was first sold for $550,000,000 to a company (MB Health) that was incorporated as a non-wholly-owned subsidiary of Macquarie Bank (and in which Macquarie Bank and other related entities held interests). Under the arrangement, Macquarie Bank would then on-sell the subsidiary to a third party and the taxpayer would share in the profits from the sale. The proceeds for the sale to MB Health comprised $50,000,000 in cash and replacement shares in MB Health. These replacement shares did not amount to a “significant stake” which thereby allowed the taxpayer to unilaterally choose the scrip-for-scrip roll-over in Subdiv 124-M of the Income Tax Assessment Act 1997 (Cth) (the ITAA 1997) to defer the gain made on the sale.

Macquarie Bank would be paid a fee of several million dollars for arranging the sale in this way. Related underwriting agreements and various options were also executed to provide for the payment of the fee, and to protect the interests of the parties. At the same time, the taxpayer was considering selling the subsidiary directly to an interested third party (Medical Benefits Fund of Australia Ltd (MBF)).

The Commissioner argued that the taxpayer and Macquarie Bank (on behalf of MB Health) had “colluded” to structure the transaction in a way that would attract the scrip-for-scrip roll-over and, as a result, the parties could not be said to be dealing with each other at “arms length” for the purpose of qualifying for the roll-over (in terms of the requirements of s 124-780(4) of the ITAA 1997). The Commissioner also argued that Pt IVA of the Income Tax Assessment Act 1936 (Cth) (the ITAA 1936) applied to the scheme (which was broadly defined as all the steps from the incorporation of MB Health to the choice of the roll-over). The Commissioner claimed that in the absence of the scheme, the taxpayer would have made a direct sale of the subsidiary to another related Macquarie Bank company, and for which roll-over could not have applied.

At first instance, in AXA Asia Pacific Holdings Ltd v FCT (2009) 77 ATR 829, the Federal Court held that the taxpayer and Macquarie Bank (on behalf of MB Health) had satisfied the arms length conditions for the roll-over as it considered there was no evidence either of collusion or the submission of one party’s will to the other. The court also found that Pt IVA of the ITAA 1936 did not apply as no tax benefit arose under the scheme as it could not be

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reasonable to expect that if the subsidiary had not been sold in this way to MB Health, it would have been sold directly to the other related Macquarie Bank company as Macquarie Bank would not have derived its fees under this sale.

On appeal, the Commissioner claimed that the court at first instance erred in its conclusion that the taxpayer and Macquarie Bank dealt with each other at arms length. In particular, the Commissioner submitted that the fact that a transaction was devised by Macquarie Bank for a fee to obtain a revenue advantage for the taxpayer meant that the parties were not dealing with each other at arms length for the purposes of s 124-780(4) of the ITAA 1997. In regard to Pt IVA of the ITAA 1936, the Commissioner claimed that the court at first instance erred in finding there was no tax benefit. The Commissioner relied on the alternative postulate that if the taxpayer had not entered into the scheme, it would have been expected to have disposed of its subsidiary directly to another related Macquarie Bank company and that the court at first instance erred in rejecting this alternative postulate merely on the basis that Macquarie Bank would not have agreed to such a transaction because it would have deprived it of its fees.

Held, dismissing the appeal:

Non-arms length dealing

(Per Edmonds and Gordon JJ):

(1) Although the structure through which the acquisition would be achieved contained features attractive to the taxpayer (including the roll-over), this did not make the transaction a non-arms length transaction. This was essentially because the taxpayer was motivated to sell its business and Macquarie Bank was motivated to acquire it in order to on-sell it.

(2) The fact that a purchaser of an asset seeks to obtain, for its own benefit, a collateral advantage from the purchase transaction (in this case, the earning of fees) over and above the acquisition of the asset, cannot of itself lead to a conclusion that the parties to the transaction were not dealing with each other at arms length.

(3) In addition, there was no evidence that the purchase price did not represent the market value of the asset. The fact that the vendor (the taxpayer) had the right to participate in any profit arising to the purchaser (Macquarie Bank) from the onward sale of the asset did not indicate otherwise. To the contrary, this reflected the bargaining power which the vendor (the taxpayer), brought to bear on the overall architecture of the transaction.

(Per Dowsett J in dissent):

(4) There was an “identity of interest” in the transaction, as between the taxpayer and Macquarie Bank, which was not simply that of vendor and purchaser as the transaction was designed to enable Macquarie Bank to obtain fees for their services, and not to just acquire an asset (that is, MB Health).

(5) In the context of this ongoing relationship (which included an interest in any profit on the re-sale of MB Health) their relationship was not at arms length and that their dealings reflected this fact.

Part IVA of the Income Tax Assessment Act 1936 (Cth)

(6) The onus is on the taxpayer to establish that a tax benefit was not obtained in connection with the scheme, that is, the taxpayer must show that the amount would not have been included, or might not reasonably be expected to have been included, in its assessable income if the scheme had not been entered into or carried out.

(7) An objective inquiry is required as to what would have been included or might reasonably be expected to have been included in the assessable income had the “scheme” not been entered into or carried out. This requires a comparison between the “scheme” and an alternative postulate, or counterfactual. The alternative postulate requires a prediction as to events which would have taken place if the scheme had not been entered into or carried out. That prediction must be sufficiently reliable for it to be regarded as reasonable and must be more than a possibility.

(8) The events that would have, or might reasonably be expected to have, taken place in the absence of the scheme and which are identified as a result of the objective inquiry are not confined or defined by the scheme itself.

18181 ATR 180] FCT v AXA ASIA PACIFIC HOLDINGS LTD

(9) In the end, the court will decide what would have been done, or might reasonably be expected to have been done, in lieu of the scheme having regard to all of the evidence that is led.

(10) The objective facts before the court at first instance were that the related underwriting agreement and options would not have been entered into had the scheme not been carried out and, therefore, the fees payable to Macquarie Bank under those agreements would have been lost. These objective facts were accepted by court at first instance and thereby discharged the taxpayer’s onus of proving that the Commissioner’s alternative postulate “was not sufficiently reliable for it to be regarded as reasonable.”

(11) The Commissioner’s submission that it was a “given” that a direct sale of the taxpayer’s subsidiary would have taken place absent the scheme is contrary to the evidence and ignores the significance of the fees that were imposed under the related underwriting agreement. In short, the evidence demonstrated that a direct sale would not have (or would not reasonably be expected to have) occurred because it would have, inter alia, denied Macquarie Bank its fees.

(12) The Commissioner’s submission that the court at first instance erred in failing to consider the “putative purpose” of the scheme was without foundation as there was no factual finding that the “putative purpose” of the scheme was to attract the benefit of the scrip-for-scrip roll-over. In addition, looking to the “putative purpose” of the scheme is not contemplated by s 177C(1)(a) of the ITAA 1936 and is contrary to the notion that the inquiry be one based on objective fact.

Cases Cited

ACI Operations Pty Ltd v Berri Ltd (2005) 15 VR 312.

Australian Trade Commission v WA Meat Exports Pty Ltd (1987) 7 AAR 248; 75 ALR 287.

AW Furse No 5 Will Trust, Trustee for Estate of v FCT (1990) 21 ATR 1123; 91 ATC 4007.

Barnsdall v FCT (1988) 19 ATR 1352; 88 ATC 4565; 81 ALR 173.

Baxter v FCT (2002) 51 ATR 209; 2002 ATC 4917; 196 ALR 519.

Collis v FCT (1996) 33 ATR 438; 96 ATC 4831.

Epov v FCT (2007) 65 ATR 399; 2007 ATC 4092.

FCT v Dalco (1990) 168 CLR 614; 20 ATR 1370; 64 ALJR 166; 90 ATC 4088; 90 ALR 341.

FCT v Hart (2004) 217 CLR 216; 55 ATR 712; 78 ALJR 875; 2004 ATC 4599; 206 ALR 207.

FCT v Lenzo (2008) 167 FCR 255; 71 ATR 511; 2008 ATC 20-014; 247 ALR 242.

FCT v Mochkin (2003) 127 FCR 185; 52 ATR 198; 2003 ATC 4272.

FCT v Peabody (1994) 181 CLR 359; 28 ATR 344; 68 ALJR 680; 94 ATC 4663; 123 ALR 451.

FCT v Spotless Services Ltd (1996) 186 CLR 404; 34 ATR 183; 71 ALJR 81; 96 ATC 5201; 141 ALR 92.

FCT v Trail Bros Steel & Plastics Pty Ltd (2010) 186 FCR 410; 79 ATR 780; 2010 ATC 20-198; 272 ALR 40.

Gauci v FCT (1975) 135 CLR 81; 5 ATR 672; 50 ALJR 358; 34 LGRA 321; 75 ATC 4257; 8 ALR 155.

Granby Pty Ltd v FCT (1995) 30 ATR 400; 95 ATC 4240; 129 ALR 503.

McAndrew v FCT (1956) 98 CLR 263; [1956] ALR 1008.

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McCormack v FCT (1979) 143 CLR 284; 9 ATR 610; 53 ALJR 436; 79 ATC 4111; 23 ALR 583.

McCutcheon v FCT (2008) 168 FCR 149; 69 ATR 607; 2008 ATC 20-009.

RAL v FCT (2002) 50 ATR 1076; 2002 ATC 109.

Spencer v Commonwealth (1907) 5 CLR 418 at 427; 14 ALR 253.

WD & HO Wills (Aust) Pty Ltd v FCT (1996) 65 FCR 298; 32 ATR 168; 96 ATC 4223.

Appeal

This was an appeal by the Commissioner to the full Federal Court from a decision of the Federal Court at first instance in which the court dismissed the Commissioner’s appeal.

M Moshinsky SC and D Mandie, for the appellant.

G J Davies QC and A T Broadfoot, for the respondent.

Cur adv vult

18 November 2010

Dowsett J.

Introduction

I have read the reasons prepared by Edmonds and Gordon JJ and agree that, to the extent that the appellant (the Commissioner) relies upon Pt IVA of the Income Tax Assessment Act 1936 (Cth) (the ITAA 1936) the appeal should fail. My reasons for that view are substantially the same as those given by their Honours. However I conclude that the Commissioner should succeed on the “roll-over” point in connection with Subdiv 124-M of the Income Tax Assessment Act 1997 (Cth) (the ITAA 1997). I do not propose to rehearse in detail the facts of the case. They appear from the judgment at first instance (AXA Asia Pacific Holdings Ltd v FCT (2009) 77 ATR 829; 2009 ATC 20-151) and from their Honours’ reasons.

I shall refer to the parties and other entities identified in the primary judge’s reasons as follows:

the appellant: the “Commissioner”;

the respondent: “AXA;”

Medical Benefits Fund of Australia Ltd: “MBF”;

AXA Australian Health Insurance Pty Ltd: “AXA Health”;

Macquarie Bank Ltd

(other than Macquarie Advisory, but including Macquarie PTG):

“Macquarie Bank”;

Macquarie’s advisory arm: “Macquarie advisory”;

Macquarie’s Principal Transactions Group: “Macquarie PTG”;

British United Provident Insurance Ltd: “BUPA”;

Macquarie Health Acquisitions Pty Ltd: “Macquarie Health Acquisitions”;

Macquarie Health Holdings Pty Ltd: “Macquarie Health Holdings”;

Macquarie Health Funding Pty Ltd: “Macquarie Health Funding”;

BUPA Australia Pty Ltd: “BUPA Australia”;

MB Health Holdings Pty Ltd “MB Health Holdings”.

18381 ATR 180] FCT v AXA ASIA PACIFIC HOLDINGS LTD (Dowsett J)

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The separate identification of Macquarie Bank, Macquarie advisory and Macquarie PTG is necessary at some stages in the consideration of this case. However, as I understand it, the only relevant legal entity is Macquarie Bank Ltd of which Macquarie advisory and Macquarie PTG are parts. The need for separate identification arises out of the different functions performed for AXA by Macquarie advisory and Macquarie PTG, leading to the erection of a “Chinese Wall” to separate the involvement of Macquarie advisory and Macquarie PTG. Of course, that process, laudable as it may have been, did not change the fact that Macquarie Bank was involved in both capacities. As will be seen, the Chinese Wall was erected after significant information had already been given to Macquarie PTG and after the general structure of the relevant transaction had emerged. As the question is whether Macquarie Health Acquisitions (or Macquarie Health Funding) dealt with AXA at arms length in the transaction for the sale of AXA Health, the effect of the Chinese Wall may be of some importance. It is common ground that Macquarie Bank’s conduct in connection with the transaction is to be attributed to Macquarie Health Acquisitions (and Macquarie Health Funding).

The relevant provisions

The ITAA 1997 provides for relief from capital gains tax where a capital gain is made as a result of the exchange of shares in the capital of one corporation for shares in the capital of another. The purpose of this relief is to facilitate takeovers. The present case concerns a transaction by which AXA transferred all of the shares in AXA Health to Macquarie Health Funding pursuant to an agreement with Macquarie Health Acquisitions which held all of the issued shares in Macquarie Health Funding. The transaction was much more complicated than is suggested by that short description and involved other parties, directly and indirectly. However it was the disposition by AXA of the shares in AXA Health which generated the relevant capital gain. It is common ground that AXA will be entitled to roll-over relief if it is able to satisfy the requirements of s 124-780(4) and (5) which provides:

(4) The conditions specified in subsection (5) must be satisfied if the original interest holder and an acquiring entity did not deal with each other at arms length and:

(a) neither the original entity nor the replacement entity had at least 300 members just before the arrangement started; or

(b) the original interest holder, the original entity and an acquiring entity were all members o f the same linked group just before that time.

Note There are some cases where a company will not be regarded as having 300 members: see section 124-810.

(5) The conditions are:

(a) the market value of the original interest holder’s capital proceeds for the exchange is at least substantially the same as the market value of its original interest; and

(b) its replacement interest carries the same kind of rights and obligations as those attached to its original interest.

…

(7) A company is the ultimate holding company of a wholly-owned group if it is not a 100% subsidiary of another company in the group.

The term “arms length” is defined in s 995-1 of the ITAA 1997 as follows:

… in determining whether parties deal at arms length, consider any connection between them and any other relevant circumstance.

Definitions

The present appeal focuses upon the meaning of the expression “did not deal with each other at arms length” where it appears in s 124-780(4) and its application to the

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facts of this case. The learned primary Judge referred to a number of cases in which similar expressions have been considered. In particular his Honour referred to definitions identified by the full court in Australian Trade Commission v WA Meat Exports Pty Ltd (1987) 7 AAR 248 at 252; 75 ALR 287 at 291 as follows:

The first matter to be determined is the meaning of the phrase “not at arms length” where used in s 4(8) of the Export Market Development Grants Act 1974 (Cth). It is, of course, often found in revenue statutes …. The ordinary meaning of the phrase is explained in Osborn’s Concise Law Dictionary, 6th ed at 32: “The relationship which exists between parties who are strangers to each other, and who bear no special duty, obligation, or relation to each other, for example, vendor and purchaser. …”

A similar explanation is given by Black’s Law Dictionary, 5th ed at 100: “arms length transaction. Said of a transaction negotiated by unrelated parties, each acting in his or her own self interest; the basis for a fair market value determination. Commonly applied in areas of taxation when there are dealings between related corporations, for example, parent and subsidiary. … The standard under which unrelated parties, each acting in his or her own best interest, would carry out a particular transaction. For example, if a corporation sells property to its sole shareholder for $10,000, in testing whether $10,000 is an ‘arms length’ price it must be ascertained for how much the corporation could have sold the property to a disinterested third party in a bargained transaction.”

I add 2 more general definitions. The Oxford English Dictionary, 2nd ed (1989) states:

… at arms length: as far out or away from one as one can reach with the arm; hence, away from close contact or familiarity, at a distance; spec. in Law, without fiduciary relations, as those of trustee or solicitor to a client; (at) arms length: …, designating a sale or transaction in which neither party controls the other.

The Collins Australian Dictionary, 7th ed (2005) defines the term as meaning:

… at a distance; away from familiarity with or subjection to another.

The cases

I should briefly examine the cases. The first in time is the decision of the full court (Beaumont, Wilcox and Burchett JJ) in WA Meat Exports. That case concerned a “grant entitlement” in respect of eligible expenditure. Eligible expenditure was expenditure which, in the opinion of the relevant decision-maker, had been incurred by a person primarily and principally for the purpose of expanding the export of goods produced, assembled or processed in Australia. Excluded from the definition of expenditure was any amount paid to a person by a prescribed associate. The term “prescribed associate” was defined to include “any person determined by the [decision-maker] to be a person not at arms length with the claimant. …” In that case the claimant company had retained the services of a former employee, such services being provided by him as an employee of another company which he owned. After the references to Osborne and Black referred to above, the court observed (at AAR 252; ALR 291):

There is no reason to suppose that the ordinary meaning of the phrase was not intended to be applied here. That is to say, the context of s 4 is consistent with the disqualification of expenditure by one party in favour of another where one of them has the ability to exert personal influence or control over the other. It is evident that the policy of the legislation would seek to exclude payments to such persons, because, if such payments were not excluded, abuse of the incentive scheme provided by the Act would be open. An obvious example is the possibility that parties might seek to inflate the fees payable for particular services.

In Re Hains; Barnsdall v FCT (1988) 19 ATR 1352; 88 ATC 4565; 81 ALR 173, Davies J considered a provision which provided that:

18581 ATR 180] FCT v AXA ASIA PACIFIC HOLDINGS LTD (Dowsett J)

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• where a taxpayer had sold property within 12 months of its purchase;

• there was no consideration, or inadequate or excessive consideration for the sale; and

• the Commissioner was satisfied that having regard to any connection between the taxpayer and the purchaser or any other relevant circumstances, the taxpayer and the other person were not dealing with each other at arms length;

then certain tax consequences followed. His Honour considered that the expression “not dealing with each other at arms length” differed from the expression “not at arms length” used in WA Meat Exports. Davies J observed that (at ATR 1355; ATC 4568; ALR 176):

That term should not be read as if the words “dealing with” were not present. The Commissioner is required to be satisfied not merely of a connection between a taxpayer and the person to whom the taxpayer transferred, but also of the fact that they were not dealing with each other at arms length. A finding as to a connection between the parties is simply a step in the course of reasoning and will not be determinative unless it leads to the ultimate conclusion.

The taxpayer had sold shares to a company which he owned. After examining a number of cases his Honour observed (at ATR 1356; ATC 4568; ALR 177):

It will be seen that those cases looked primarily to the relationship between the contracting parties and to influence and control.

I do not disagree with this analysis, but I accept … [the] submission that there may be transactions between related parties in which the parties deal with each other at arms length. This may occur notwithstanding a close relationship between the parties or the power of one party to control the other.

In that case the taxpayer submitted that the Commissioner, in reaching his decision, had considered only the relationship between the parties and not the nature of the transaction, or the circumstances in which the parties had dealt with each other. Davies J rejected this criticism, observing that there was other material bearing upon the question, including evidence that the shares were not sold on the open market, but rather transferred pursuant to a private transaction “of a somewhat unusual character.” The “unusual” nature of the transaction was that the taxpayer had acquired rights to the allotment of shares in a public company and granted to his company options to acquire such shares when they were allotted. The price payable was such that the taxpayer’s costs and receipts matched. On this material his Honour considered that the conclusion was inevitable that the parties had not dealt at arms length, observing (at ATR 1357; ATC 4569; ALR 178) that:

Proof that a transaction was fair is not sufficient to show, in the context, that the dealing was at arms length. The term “at arms length” in s 26AAA(4)(b) is not to be construed as meaning “for a fair price.” Indeed, this provision did not turn its attention primarily to price, but the price paid may be a relevant factor. The provision did not purport to fix a fair price for the transaction but rather, when a finding had been made that the dealing was not at arms length, fixed and [sic] arbitrary consideration, the value of the property at the time of its sale.

The subject transaction was one between [the taxpayer] and his private company. It was a private transaction with a company which he controlled and which was his investment and share dealing arm. Such a transaction is not an arms length dealing for the purposes of s 26AAA(4).

Trustee for Estate of AW Furse No 5 Will Trust v FCT (1990) 21 ATR 1123; 91 ATC 4007 concerned a provision in the ITAA 1936 dealing with assessable income:

… derived by a trustee, directly or indirectly, under or as a result of an agreement … any 2 or more of the parties to which were not dealing with each other at arms length in relation to

186 FEDERAL COURT OF AUSTRALIA [(2010)

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the agreement and the amount of the assessable income so derived is greater than the amount … of the assessable income that, in the opinion of the Commissioner, would have been derived by the trustee, directly or indirectly, under or as a result of that agreement if the parties to the agreement had dealt with each other at arms length in relation to the agreement. …

Hill J said (at ATR 1132; ATC 4014-4015):

The first of the 2 issues is not to be decided solely by asking whether the parties to the relevant agreement were at arms length to each other. The emphasis in this subsection is rather upon whether those parties, in relation to the agreement, dealt with each other at arms length. The fact that the parties are themselves not at arms length does not mean that they may not, in respect of a particular dealing, deal with each other at arms length. This is not to say that the relationship between the parties is irrelevant to the issue to be determined under the subsection.

His Honour then referred to the decision of Davies J in Hains and continued:

What is required in determining whether parties dealt with each other in respect of the particular dealing at arms length is an assessment whether in respect of that dealing they dealt with each other as arms length parties would normally do, so that the outcome of their dealing is a matter of real bargaining.

Both Hains and Furse highlight the need to examine the course of the dealings between the parties in order to determine whether they have dealt with each other at arms length.

Granby Pty Ltd v FCT (1995) 30 ATR 400; 95 ATC 4240; 129 ALR 503 concerned the calculation of a cost base for capital gains tax purposes. Section 160ZH(9)(c) provided that in determining such cost base, certain consequences would follow if the consideration paid by the taxpayer was less than the market value of the asse