Ashwick (Qld) No 127 Pty Ltd (ACN 010 577 456) v Commissioner of Taxation

Ashwick (Qld) No 127 Pty Ltd (ACN 010 577 456) v Commissioner of Taxation - [2009] FCA 1388 - FCA 2009 case summary — Zoe

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TABLE OF CONTENTS THE CORPORATE STRUCTURE AND HISTORY OF THE FOSTER'S GROUP ACRONYMS AND ABBREVIATIONS THE FACTUAL BACKGROUND THE COMMISSIONER'S ASSESSMENTS, THE APPLICANTS' OBJECTIONS AND THE PRESENT PROCEEDINGS (i) ELFIC (ii) EFGS (iii) EFGA (iv) FGL (v) Amayana (vi) Ashwick (vii) Nexday (viii) EFGT (vix) EFG Investments THE COMMON ISSUES THE DEDUCTIBILITY OF BAD DEBTS WRITTEN-OFF (i) The statutory provisions (ii) EFGA's bad debt deductions (a) The ELFIC/EFGA Bad Debt Deduction (b) The EFGS/EFGA Bad Debt Deduction (c) The Commissioner's contentions in respect of the bad debts written off by EFGA (d) EFGA's contentions as to its bad debt deductions (e) Consideration of EFGA's bad debt deductions (iii) EFGT's Bad Debt Deductions Consideration of EFGT's bad debt deductions (iv) FGL's Bad Debt Deductions Consideration of FGL's Bad Debt Deduction (v) Amayana's Bad Debt Deductions Consideration of Amayana's Bad Debt Deductions THE DEDUCTIBILITY OF INTEREST EXPENSES INCURRED BY BORROWER COMPANIES WITHIN THE FOSTER'S GROUP The applicants' contentions on deductibility of interest claimed by ELFIC Consideration of deductibility of interest claimed by ELFIC Aspects of EFGA's activities relevant to its claim for a deduction in respect of interest The applicants' contentions on deductibility of interest claimed by EFGA Consideration of deductibility of interest claimed by EFGA Aspects of Amayana's activities relevant to its claim for a deduction in respect of interest. The applicants' contentions on the deductibility of interest claimed by Amayana Commissioner's contention as to the deductibility of interest claimed by Amayana Consideration of deductibility of interest claimed by Amayana Aspects of the activities of EFGS relevant to its claim for a deduction of interest Applicants' contentions as to the deductibility of interest claimed by EFGS The Commissioner's contentions on the deductibility of interest claimed by EFGS Consideration of the deductibility of interest claimed by EFGS Aspects of EFGT's activities relevant to its claim for a deduction in respect of interest Applicants' contentions on the deductibility of interest claimed by EFGT The Commissioner's contentions on the deductibility of interest claimed by EFGT Consideration of deductibility of interest claimed by EFGT Was the interest expenditure on capital account? DEDUCTIBILITY OF LOSSES TRANSFERRED TO ASHWICK, NEXDAY AND EFG INVESTMENTS (i) Ashwick Consideration of Ashwick's claimed deduction for a tax loss transferred from Amayana (ii) Nexday Consideration of Nexday's claimed deduction for a tax loss transferred from Amayana (iii) EFG Investments Consideration of EFG Investment's claimed deduction for a tax loss transferred from EFGS PART IVA The existence of a "scheme" Tax Benefit Purpose (i) Manner in which the scheme was entered into or carried out - s 177D(b)(i) (ii) The form and substance of the scheme - s 177D(b)(ii) (iii) Time of entry into alleged scheme and period during which it was carried out - s 177D(b)(iii) (iv) The result in relation to the operation of the Act that but for Part IVA would be achieved by the scheme - s 177D(b)(iv) (v) Any change in the financial position of the relevant taxpayer that has resulted, or will result, or may reasonably be expected to result from the scheme - s 177D(b)(v) (vi) Any change in the financial position of a person with a connection with the relevant taxpayer - s 177D(b)(vi) (vii) Any other consequences for the relevant taxpayer or for any person referred to in (vi) of the scheme being entered into or carried out - s 177D(b)(viii) (viii) Nature of any connection between the relevant taxpayer and any person referred to in (vi) - s 177D(b)(viii) Conclusion as to Part IVA GENERAL CONCLUSION (i) Proceeding numbered VID 861 of 2006; Ashwick (Qld) No 127 Pty Ltd (ii) Proceedings numbered VID 123 of 2007, VID 124 of 2007 and VID 125 of 2007; Ashwick (Qld) No 127 Pty Ltd (iii) Proceeding numbered VID 126 of 2007; Nexday Pty Ltd (iv) Proceeding numbered VID 127 of 2007; EFG Investments Pty Ltd (v) Proceeding numbered VID 128 of 2007, Amayana Pty Ltd (vi) Proceeding numbered VID 129 of 2007; Foster's Group Ltd (vii) Proceedings numbered VID 130 of 2007, VID 133 of 2007 and VID 134 of 2007; Elfic Pty Ltd (viii) Proceeding numbered VID 131 of 2007; EFG Treasury Pty Ltd (vix) Proceeding numbered VID 132 of 2007; EFG Australia Pty Ltd (x) Proceeding numbered VID 135 of 2007; EFG Securities Pty Ltd

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ACRONYMS AND ABBREVIATIONS 4 Throughout these reasons acronyms and abbreviations are generally used to refer to entities or expressions which recur with some frequency. In the case of corporate entities the full name of the company is set out immediately before the relevant acronym or abbreviation where it first occurs. Expression or Entity Acronym or Abbreviation Amayana Pty Ltd Amayana AML Finance Corporation Limited AML Finance Ashwick (Qld) No 127 Pty Ltd Ashwick Bank Bill Rate BBR EFG Australia Pty Ltd EFGA EFG Financial Limited EFG Financial EFG Investments Pty Ltd EFG Investments EFG Securities Pty Ltd EFGS EFG Treasury Pty Ltd EFGT Elders Lensworth Finance Limited Group Lensworth Elders Rural Finance Limited Elders Rural Finance ELFIC Pty Ltd (formerly Elders Finance and Investment Co Limited) ELFIC FBG Treasury Aust Pty Ltd FBGT Foster's Group Ltd (formerly IXL Ltd) FGL Harlin Holdings Pty Limited Harlin Income Tax Assessment Act 1936 (Cth) the 1936 Act Income Tax Assessment Act 1997 (Cth) the 1997 Act Nexday Pty Ltd Nexday Reduction of Assets Management Committee RAMCO The Finance Group Collectively the subsidiaries of FGL which from time to time made up the Finance Group The Foster's Group Collectively FGL and its subsidiaries from time to time including those gathered in the Finance Group The respondent Commissioner of Taxation the Commissioner

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THE FACTUAL BACKGROUND 5 On 3 December 1984, EFGA Pty Ltd ("EFGA") was incorporated as a new holding company for the subsidiaries which comprised the Finance Group of FGL's subsidiaries. It was perceived that EFGA would have a higher credit rating than its subsidiaries separately enjoyed and would be able to borrow funds for the members of the Finance Group from external lenders more advantageously than those members individually could achieve. There was also some expectation that the holding company for the Finance Group might obtain a banking licence. 6 Before the incorporation of EFGA, ELFIC Pty Ltd (formerly Elders Finance and Investment Co Limited) ("ELFIC") had carried on the business of a merchant banker and its activities included the receiving of surplus funds on deposit from other members of the Finance Group and the making of advances by way of loans at a margin as required to members of the Finance Group. However, the greater proportion of ELFIC's income by way of interest was derived by loans to third parties. By 30 June 1994, ELFIC's gross assets had grown to $690 million. 7 After its incorporation and until about 2002, EFGA stood alone and separate from other entities in the Foster's Group as a corporation with its own statutory accounts. Also after its incorporation, EFGA succeeded to ELFIC's share of a US$500 million global note facility which had been raised as to US$300 million by FGL and as to US$200 million by ELFIC on behalf of the Finance Group. Upon its entry into that facility, EFGA, in February 1985, achieved a credit rating by Australian Ratings of A+. On 15 July 1985, a new charter was formulated for EFGA applicable to the whole of the Finance Group, each individual component of which was also given its own separate approved charter and cross-guarantees to a trustee were established between EFGA, ELFIC, Elders Rural Finance and Elders Lensworth Finance Limited Group ("Lensworth") which later became Lensworth Glenmore Park Limited and was a central company of the Lensworth Group which carried on the property finance business of the Elders Finance Group. 8 EFGA also succeeded to ELFIC's role as a licensed participant in the money market and a foreign exchange dealer. It took until 1 July 1986 for the legal and systems requirements for that transfer to be implemented. By 30 June 1987, EFGA's creditors and borrowings had grown to about $1.4 billion and by 30 June 1988 to about $2.3 billion. 9 Between 1985 and 1986, EFGA took over the conduct of treasury activities for the Finance Group. That involved it in making loans of about $700 million to ELFIC and $40 million to EFG Securities Pty Ltd ("EFGS") at benchmark rates like the Bank Bill Rate ("BBR") plus a margin. ELFIC in turn on-lent the funds to retail customers subject to credit limits set by the Board of EFGA and an obligation to submit monthly management reports to that Board. The fixing of interest rates charged to members of the Finance Group occurred at least annually and was intended to impose a discipline on EFGA executives to improve its performance as measured by a "profit" on the notional cost of capital employed. Finance Group subsidiaries were required to account for "losses" on defaulting loans to retail customers, which were set-off against "profits" derived from performing loans and other activities. 10 Mr Gerald John van Wyngen, who was the Director from 1986 to 1990 of EFG Treasury Pty Ltd ("EFGT") deposed to its activities during his directorship when he oversaw its five divisions; (a) Trading, which undertook foreign exchange trading and funding, and dealt in foreign exchange options; (b) Risk Management, which acted as a futures broker for EFGT and third party customers; (c) Funding, which raised funds to finance the activities of entities in the Finance Group as well as external parties, and traded in bank bills, forward rate agreements and other derivatives; (d) Capital Markets, which traded in bonds, convertible notes and interest rate swaps and managed commodity risks for mining houses; and (e) Capital Markets Technologies, the Synthetic Options joint venture in San Francisco. EFGT had originally operated as a subsidiary of ELFIC but in July 1986 it passed into the direct control of EFGA. 11 Mr van Wyngen described EFGT as a "profit centre" with a budget requiring a return on capital employed after all expenses, including head office cost allocations. He gave evidence that in early 1986, the budget for EFGT required it to make a profit contribution of nearly $3 million (before tax) to ELFIC, with around $10 million in revenue, $6 million in direct operating expenses and $1 million in allocated central expenses. As at 31 May 1986, EFGT was approximately $300,000 behind budget in terms of its net contribution. 12 For the year ended 30 June 1988, EFGT made a direct management return (measured as revenue less transaction costs, standby costs, provisions and direct operating expenses) of $12.7 million. The return of EFGT's funding business, before overheads, was $8.5 million, compared with a budget of $2.4 million. For the year ended 30 June 1989, EFGT made a direct management return of $7.5 million, to which the funding business contributed $3.3 million. Following a report by PA Consulting Group dated 13 April 1989, the division of EFGT that conducted futures broking and trading was sold as it was no longer considered profitable. 13 According to Mr van Wyngen, EFGT raised funds from several external sources, including prime corporations (being companies with a rating of "A-"or higher) and banks in the money and term deposit markets, discounting bills of exchange, retail deposits from the pastoral and trustee businesses and overseas bank lines. The funding obtained was on a mix of terms (tenor), ranging from 11.00 am and 24 hour call, through to term deposits of 12 months or more. The rate of interest on these funds depended on the tenor and the then applicable interest yield curve across the range of maturity terms. 14 Each year, as part of the annual budgeting process, the Finance Group entities carrying on external lending activities forecast the funds required for each month over the following financial year. When funding was required, EFGT would process a pre-numbered deal ticket and provide the funds to the other entities, including ELFIC and EFGS, for lending to their customers. In April 1988, EFGT's Australian region balance sheet totalled $2.5 billion, which made it the biggest balance sheet for an Australian non-bank financial institution. 15 EFGT's strategy for maximising profit was to pursue opportunities to raise funds at the lowest possible cost, anticipate interest rate changes, lend at higher yields and manage foreign exchange and interest rate risk. Further considerations included the need to maintain sufficient liquidity to comply with banking covenants and to be in a position to provide the funds required by the borrowing entities within the Finance Group at relatively short notice, as well as managing prudently to protect against unexpected turmoil in financial markets. 16 According to Mr van Wyngen, a major technique by which profits were maximised was "gapping" or "mismatching". This involved anticipating movements in interest rates across a spread of maturity terms and exploiting differences between the rate at which money was borrowed by EFGT and on lent to external counterparties and other entities within the Finance Group, as well as Elders Resources Finance. This was managed across the portfolio by use of physical means like varying the tenor of liabilities and assets (such as bank and non-bank bills of exchange) and synthetic products, such as bank bill futures, forward rate agreements and interest rate swaps. 17 From around 1988, capital adequacy guidelines for banks were introduced by the Reserve Bank of Australia, which required their assets to be risk weighted and gearing limited to 12.5 times capital. This made funding cheaper for banks (which had a lower risk weighting), and more difficult to obtain and more expensive for non-bank financial institutions such as EFGA (which was not under the control of the Reserve Bank of Australia and had a higher risk weighting). From around 1988, Mr van Wyngen advised that EFGA should obtain a banking licence to avail itself of these benefits. 18 Lending transactions occurred between EFGT and external counterparties for the purpose of managing EFGT's liquidity. The counterparties were banks, prime merchant banks, finance companies and prime or near prime companies for which credit limits had been approved by credit personnel based in the Finance Group's Melbourne office. The loans were nearly always lent on "11 am" or "24 hour" call and were unsecured. The terms able to be agreed by EFGT were governed by an operating charter, which set out the lines of authority, operating limits, and approved product mixes. 19 Funding was provided to other entities in the Finance Group, such as ELFIC and EFGS, by way of loans at interest. From 1986 to 1990, the interest charged was normally calculated by applying a particular margin to the 90 day BBR on a monthly basis. In early 1986, the margin above BBR had been set at 0.7%. The margin was changed to 0.6%, with effect from October 1986. In addition, a charge was agreed to be paid by the borrowing entities for the facilities which were required to be held by the Finance Group to have sufficient liquidity to meet the funding requirements of the borrowing entities. Finally, a "penalty" rate was payable if the borrowing entity required materially less or more funding from EFGT than forecast in the budgets. Interest accruing on loans from EFGA (through EFGT) to other entities in the Finance Group was ordinarily calculated on a daily basis, and capitalised monthly. 20 Where funding was provided by EFGT to a borrowing entity for a specific loan by the borrowing entity to a customer, there was a risk of a differential between the timing of interest receipts and payments. Although interest was capitalised monthly on balances owed by the borrowing entities to EFGT, it was not paid until the borrowing entities received funds from their clients. However, EFGT was at liberty to exploit the interest rate risk in how it sought its own funding, for example by "gapping". 21 The term of loans to other entities in the Finance Group was 24 hour call except for matched funded loans or where specifically agreed otherwise. In substance, this meant that the money was rolled over from day to day, with the borrowing entity being responsible for repaying the loans irrespective of how it employed the funds. The loans to other entities in the Finance Group were unsecured. 22 Mr van Wyngen gave evidence that the amount and type of security required from customers was determined and administered by the borrowing entities as part of their normal external lending businesses. In all cases, the credit risk was borne by borrowing entities. If an amount was not paid by a customer, the borrowing entity remained liable to EFGT for principal and accrued interest on the loan provided by EFGT. 23 In late December 1989, Dresdner Bank agreed to purchase the business of EFGT (except for its funding operations). Mr van Wyngen transferred with the rest of the EFGT operations to Dresdner Australia, and was subsequently appointed Managing Director when the sale was completed in early 1990. 24 Between July 1985 and June 1986 the activities of companies in the Finance Group expanded considerably, enabling EFGA to report a profit for that financial year of approximately $34.2 million. By May 1987 the management of the Finance Group had been restructured along regional lines with a separate Regional Managing Director and Regional Board for each of Australia, New Zealand, Asia, the United Kingdom / Europe and the United States of America. Each region had its own treasury. By 30 June 1987, the total assets of the Finance Group had grown to approximately $4.1 billion and the net operating profit to about $64 million. 25 The share market crash of October 1987 thwarted a proposal to split the Foster's Group into four separate publicly-listed companies, one of which would have been the Elders Finance Group. Several companies in which the Finance Group had shareholdings were affected by the share market crash. However, there was little concern about the solvency of the Finance Group itself as its capital and reserves were regarded as sufficient to absorb those losses. In spite of the stock market crash and the abandonment of the proposed demerger of FGL, EFGA continued to grow steadily. In the year ended 30 June 1988, the Finance Group was the largest merchant banker in Australia, reporting a record profit of $63.4 million and assets of $5 billion and, as at 30 June 1989, EFGA had 141 subsidiaries principally in Australia and New Zealand with some located elsewhere in the world. In the three years ending 30 June 1989, EFGA's consolidated accounts recorded significant net operating profits for the Finance Group. In the same period ELFIC and EFGS earned substantial net income but incurred significant interest expenses almost exclusively on intra-group loans which were used as circulating capital in their businesses. In the year ended 30 June 1988, ELFIC suffered an operating loss of $15 million and a loss on extraordinary items of $24 million including a write-down in investments in subsidiaries (one of which was EFGS) of $19 million. In the same year EFGS suffered an operating loss of $12 million. However, not all the companies in the Finance Group sustained losses in that period. The Lensworth Group, with activities in the property sector, recorded increased operating profits in 1988 as a result of which the assets of the Lensworth Group increased by something of the order of 30%. By the year ended 30 June 1989, ELFIC's operating loss had grown to $86 million and that of EFGS to $8 million. EFGA, however, still recorded a consolidated profit for the Finance Group in the same year of $81 million, largely derived from the continuing profitability of the Lensworth Group. In June 1989, EFGA provided additional share capital of $80 million to ELFIC which, in turn, provided additional share capital of $20 million to EFGS. By that means both subsidiaries reported positive net assets as required to preserve their money market dealers' licences. 26 In late 1988, Australian Ratings downgraded EFGA's credit rating from "A+" to "BBB+" and in January 1989 indicated its intention to downgrade EFGA's credit rating further in response to concerns about the quality of its assets and the impact of new capital adequacy guidelines. Those guidelines required each bank to maintain a certain level of capital, depending on the risk weighting accorded to its assets. EFGA had a higher risk weighting because it was treated as a corporate borrower rather than a bank. As a result, lenders charged higher rates of interest to EFGA, which, in turn, had to charge its customers higher interest rates than those charged by banks. 27 Australian Ratings ultimately did not further downgrade EFGA's rating. Nevertheless, the Finance Group went ahead with plans to become a specialist merchant bank, entailing a cap on assets as at 30 June 1989 and a reduction in total assets of $1 billion by 30 June 1990. In the 1989 financial year, EFGA posted a consolidated profit before tax of $90 million. However, EFGS and ELFIC both suffered net operating losses and required capital injections from EFGA to enable the companies to report positive net asset positions and retain the licences required to operate their businesses. After the middle of 1989, FGL, at the request of EFGA, and prompted by external lenders' having declined to renew EFGA's debt financing, provided EFGA with a standby facility of $400 million at an interest rate of 2% above the BBR and on condition that EFGA reduced the facility to $250 million by October 1989. Although that reduction was apparently achieved, a further tightening of the liquidity of the Finance Group necessitated an increase, in December 1989, to $500 million in the standby facility provided by FGL to EFGA. 28 In August 1989, Harlin Holdings Pty Limited ("Harlin") launched a bid for FGL and subsequently attained a 55.82% shareholding. The takeover bid boosted the Finance Group's ability to access the funds required for the orderly sale of assets. However, the Finance Group's liquidity and funding position continued to decline in the face of increased customer defaults, a depressed economy and ongoing funding commitments. In August 1989, a $400 million standby loan facility was granted by FGL to EFGA, under which interest was charged at a margin of 2% above the then applicable BBR. 29 In November 1989, Australian Ratings downgraded FGL's credit rating to "BB/B.1" and EFGA's credit rating to "BB-/B.1". As a result, EFGA's loans no longer fitted the investment criteria of its major lenders and banks began to withdraw funding. After the downgrade, the Board of EFGA agreed to accelerate the strategic sell-down of the Finance Group's assets in order to continue its operations. A steering committee was formed to downsize the Australian and New Zealand businesses and coordinate reductions and sell-offs in other regions. Between January and March 1990, the steering committee oversaw the sale of the Finance Group's assets. During this period, the Finance Group subsidiaries cut back their lending activities and concentrated on funding existing committed liabilities. However, EFGA continued, where required, to make loans at a margin to the Finance Group subsidiaries. 30 In March 1990, FGL announced its plan to focus solely on its brewing business and divest itself of all of its other businesses, including those conducted by the Finance Group. As a result, many lenders to the Finance Group, caught off-guard by the announcement, sought to switch existing external lines of credit to FGL. At that stage, external funding of the Finance Group was over $3 billion. In order for EFGA to realise the Finance Group's assets and maximise shareholder returns, it became necessary to repay facilities as they matured and, to the extent that asset sales could not fund this, to draw on alternative funding from FGL. Between February and April 1990, funding to EFGA by FGL doubled to approximately $301 million. 31 On 22 March 1990, the Board of EFGA established the Reduction of Asset Management Committee ("RAMCO") to facilitate the expeditious realisation of assets, disposal of businesses and repayment of debt. RAMCO had equivalent authority to the EFGA Board and continued to meet till July 2004. In May 1990, the directors of the companies in the Finance Group called on FGL to provide them with letters of comfort so that they could sign the statutory accounts referable to companies in the Finance Group. 32 By 30 June 1990, the Finance Group's assets had fallen to $2.7 billion following the sale of the Australian treasury operation, the Australian trustee business and stockbroking businesses in Australia, New Zealand and the United Kingdom. At this stage, the realisation of the Finance Group's assets was expected to be completed by 30 June 1990. The debt owed by EFGA to the Foster's Group was now $435 million, comprising the sum of direct liabilities of $417 million and bank borrowings transferred from EFGA to the Foster's Group of $18 million. This was forecast to increase to $820 million by 31 July 1990 and, thereafter, gradually reduce and be fully repaid by 30 June 1992. The increase in debt to the Foster's Group was largely the result of external bank funding being withdrawn or not being renewed and facilities being transferred to, or replaced by, new funding from the Foster's Group. As well, FGL provided a guarantee of performance of the obligations of Finance Group companies to certain creditors to preserve lines of credit from those creditors. That was done rather than increasing the share capital of the Finance Group companies because of the risk that such equity funds might have become available to third party litigation creditors of companies in the Finance Group. Until this time, EFGA had been charging the Finance Group companies at its cost of borrowing plus a margin of 0.6%. From 1 September 1990, EFGA continued to charge interest but provided further moneys at cost of funds with no margin. 33 In July 1990, another wholly owned subsidiary of FGL, Amayana Pty Ltd ("Amayana") made a loan of $34.8 million to EFGA using funds which Amayana had borrowed from its subsidiary, FBG Treasury Aust Pty Ltd ("FBGT"). Both the loan from FBGT to Amayana and that from Amayana to EFGA were at the standard intra-company interest rates charged by FBGT. 34 The refinancing of the Finance Group's commitments during the latter half of 1990 became a major drain on FGL's funds. However, had ELFIC, Lensworth or Elders Rural Finance defaulted under the US$ Denominated Note Global Facility noted at [7] above, cross-default clauses could have been triggered imperilling the financial viability of the whole Foster's Group. 35 Money raised from the sale of assets to external purchasers and the transfer of assets to other members of the Foster's Group, as well as from the repayment of customer loans, was used at this time to repay bank loans, to continue funding to external customers where appropriate and, to the extent available, to repay funding provided by the Foster's Group. However, the necessity of acquiring assets from debtors in settlement of their debts hindered the Finance Group's realisation program because such property assets had to be managed and took time to realise. By July 1990, the Board of EFGA had formed the view that, because of the depressed Australian property market, the Lensworth Group's property book could not be sold at that time except on "fire sale" terms and prices. Other assets of the Finance Group were sold off, more than half of them by June 1990, and those sales enabled the balance of debts owed to EFGA by members of the Finance Group, other than ELFIC, EFGS and Lensworth, to be reduced to nil by 1992. 36 EFGA continued to lend to Finance Group subsidiaries to fund theirexisting liabilities to external customers where termination of the facilities couldnot be negotiated, and continued lending to customers if the further amount would not only be repaid but also assist the recovery of the entire amount outstanding. Up until around July 1992, RAMCO's terms of reference did not impose limits on the amounts that could be advanced to existing customers, although they were typically loans of under $1 million. In July 1992, RAMCO's terms of reference were amended and authority limits were introduced formalising the process for approving additional loans to existing customers. These additional loans to existing customers were funded by loans from EFGA to the relevant Finance Group subsidiaries (including ELFIC and EFGS). Generally, the sources of the funds for these additional loans were either the proceeds of asset realisations, or funds drawn by EFGA from the Foster's Group. 37 During 1991, the Finance Group suspended customer accounts for non-performing loans, ceasing to record interest as income where there were doubts about the relevant customers' ability to continue paying interest. This impinged on EFGA's profit and loss statement as funding costs continued to be recognised. However, the customers were still expected to repay the principal amount and the suspended interest. 38 In March 1991, EFGA reported a deficiency of shareholders' funds. This was due to the allocation of significant provisions to closing down costs and doubtful debts. Furthermore, the interest payable to the Foster's Group on funds advanced to the Finance Group exceeded the interest received from customers whose loan accounts had been suspended. 39 In April 1991, EFGA made a request to the Foster's Group for $400 million in interest-free funding, in order to eliminate a budgeted loss for the 1992 financial year and to prevent external auditors from requiring additional provisioning of $60 million in the Finance Group accounts. That proposal was rejected by the Board of FGL. 40 In early 1991, concerns were also raised about the unsecured nature of loans provided by the Foster's Group to the Finance Group, which would rank equally with the debts of any litigation creditors. As the level of debt rose, obtaining security for the debts owing by EFGA to the Foster's Group was made a priority. By this stage, the amount due to the Foster's Group had increased to nearly $1.4 billion, vastly exceeding the original forecast of $820 million. This was attributed to a slowdown in asset sales as a result of the economic downturn, and a miscalculation of the volume and speed at which the banks would withdraw their funding support of the Finance Group. 41 Pursuant to the refinancing arrangements, EFGT became, in May 1991, the funding conduit to EFGA. The Foster's Group took security over EFGT's assets in respect of the debt owed by EFGT to the Foster's Group. In turn, EFGA and certain Finance Group subsidiaries guaranteed EFGT's obligations to the Foster's Group and granted charges over their assets to support those guarantees. The Foster's Group thereby became a secured lender with an entitlement to realise the assets of EFGT and the Finance Group subsidiaries should EFGT default in its repayment obligations, enabling the Foster's Group to continue to fund the Finance Group without exposing the additional loan funds to the claims of third party litigants. From October 1991, loans were made by the Foster's Group to the Finance Group through EFGT under a Security Note arrangement. EFGA and some of its subsidiaries, including ELFIC and EFGS guaranteed repayments by EFGT under these arrangements and gave charges over their assets to secure their obligations under the guarantees. The effect of these arrangements was to cause loans by FGL to EFGA and AML Finance Corporation Limited ("AML Finance") and by AML Finance to EFGA to be repaid and replaced with loans by FGL to EFGT secured over the bulk of the assets of EFGA and its subsidiaries in the Finance Group and by EFGT to EFGA. 42 By 30 June 1991, it had become apparent that EFGA, ELFIC and EFGS each had, or was likely to have, a deficiency of net assets of $194 million, $808 million and $40 million respectively. On 12 August 1991, the FGL Board gave "in-principle" approval to the provision of a letter of comfort to the Finance Group subsidiaries. The directors of EFGA, ELFIC and EFGS subsequently formed the view that those companies would be able to pay their debts as and when they fell due, and signed off on their accounts. 43 By September 1991, the recession was hindering the asset realisation program and increasing the incidence of defaults by customers unable to meet their repayment obligations to the Finance Group companies. Price Waterhouse, as auditors of EFGA, concluded that general provisions should be increased by between $35 million to $50 million above the existing provisions of $62 million. FGL had made a loss of $43 million in the year ended 30 June 1991 and had no accumulated distributable reserves. As payment of a dividend without the consent of lenders could have been a breach of banking covenants, the FGL Board resolved not to pay a dividend for the 1991 financial year. 44 After the security structure noted at [41] above had been implemented in October 1991, it was decided to pursue an orderly realisation of the Finance Group's assets rather than aggressively selling down those assets. Between 1991 and 1998, the performance of the remaining assets of the Finance Group continued to be monitored by RAMCO and, as thought appropriate, Finance Group companies were directed to foreclose on securities held over properties of defaulting external borrowers. Additional finance was provided by EFGA to some external customers to enable them to maintain assets which could not yet be sold at acceptable prices. Although the asset realisation program had, by mid 1992, bought about an improvement in the net liability position of the Finance Group, it was perceived by then that the program would have to be extended to mid 1997 before it could be completed. 45 After Australia, the United Kingdom and the United States had gone into recession in 1991, the Board of EFGA determined that the Lensworth Group's property business should be realised over a period of time with the other residual assets of the Finance Group. Accordingly, the RAMCO and Lensworth Group assets were brought under one management organisation and the time frame for the orderly realisation strategy was extended to between five and seven years. 46 Before 1992, the advances from the Foster's Group to the Finance Group had outstripped the repayments. However, after July 1992, the Finance Group's principal repayments and interest payments to the Foster's Group outpaced the additional advances. The cash was being generated from realising loans, selling assets where the Finance Group had security and selling other assets and businesses of the Finance Group. By December 1991, the undrawn funding commitments of the Finance Group had dropped from $900 million to $185 million. 47 In June and August 1992, in response to concerns about EFGA's solvency, all staff were transferred from EFGA to EFGT. The human resources reshuffle coincided with Harlin's going into receivership on 6 July 1992 and the acquisition of its shares in the Foster's Group by BHP Limited. 48 In September 1992, the Board of FGL approved an increase in provisioning of $360 million to cover additional specific provisions, additional general provisions and work out costs, and $300 million for future funding costs. At about the same time, FGL provided another letter of comfort to enable the Finance Group directors to sign off on their respective company accounts. Over time, a portion of the provisions was in fact reversed, thereby realising profits for the Finance Group. On 15 September 1992, FGL made a rights issue to raise new capital which was successful in raising $1 billion. That enabled a large portion of FGL's debt to be repaid and effectively brought FGL's liquidity problems to an end. 49 Throughout 1993 and 1994, the continuation of the asset realisation program resulted in a net cash outflow from the Finance Group to the Foster's Group. New strategies were developed to maximise the realisable value of assets over which the Finance Group had security before the Finance Group decided, in 1995, to retain the land holdings which had been acquired in order to enhance their value through rezoning and development. Nevertheless, EFGA continued to make losses, except for the 1995 year, generally due to provisions for the decline in value of investments and loans and bad debt write-offs. ELFIC and EFGS continued to record losses because their intra-company debts exceeded income from their business activities. 50 Despite this progress, it remained necessary to obtain comfort that the Foster's Groupwould continue to provide financial support to the Finance Group companies that were net asset deficient so that the directors of those companies could sign off on the statutory accounts. 51 It was at around this time that EFG Financial Limited ("EFG Financial"), a subsidiary of ELFIC Holdings BV and a Finance Group company incorporated in Cyprus, was in the process of being sold. As at 31 March 1996, EFG Financial's trial balance recorded debts owing to it by EFGA in the amounts of US$66,306,653.04 and US$35,620,265.31. In preparation for the sale of ELFIC Holdings BV and its subsidiaries, the debts owed by EFGA to EFG Financial were assigned from EFG Financial to Amayana for $1. Under the security structure described at [41] above, FGL continued, until 30 June 1998, to charge interest on its loans to EFGT. In turn, EFGT continued to charge interest on its loans to EFGA. The existing loans from Amayana to EFGA remained unpaid and were unsecured. The loans by FGL to EFGT were at interest and the interest so charged was returned as assessable income by FGL. From time to time, EFGT made payments and repayments reducing the balance of its debts from about $1,143 million to about $842 million by 30 June 1998. Subsequent payments by EFGT between 1999 and 2001 amounted to $61,830,522. EFGT, in turn, charged interest on intra-group loans from it to, in particular, EFGA. That interest was included in EFGT's assessable income. Substantial payments and repayments on account of those debts were made by EFGA to EFGT between October 1991 and 30 June 1998. 52 Loans were also made at interest from FBGT to Amayana which on-lent the borrowed funds, also at interest, to EFGA. The interest was included in Amayana's assessable income. Although payments and repayments were made from time to time on behalf of EFGA to Amayana, EFGA's total indebtedness to Amayana rose from about $251 million in 1991 to about $325 million in 1998. 53 EFGA made available to subsidiaries in the Finance Group, particularly ELFIC and EFGS, the funds which it had borrowed from EFGT and Amayana. EFGA charged interest to the borrowers and returned such interest as assessable income. 54 In early 1998, Mr Neufeld, who was Senior General Manager within the Finance Group from 1995 to 2001, conducted a "recoverability review" to assess the prospects of recovering debts owed respectively by ELFIC and EFGS to EFGA, by EFGA to EFGT and by EFGT to FGL. He assessed ELFIC's "best case" recovery at $92 million being $54 million from external customers and $38 million from related party customers. In the same way, Mr Neufeld assessed the "best case" recovery of EFGS at $6 million, all from one external customer, and that of EFGA at $197.2 million from all assets, not merely from loans to ELFIC and EFGS. EFGT's "best case" recovery was similarly assessed at $208 million, all from related party customers. In the light of those assessments, Mr Neufeld thought that, of the amount of $1.29 billion owed by ELFIC to EFGA, $1.2 billion should be written off as a bad debt. Similarly, he recommended that $99 million of the $106 million owed by EFGS to EFGA should be written off and $657 million of $850 million owed by EFGA to EFGT should be written off. Mr Neufeld considered that $268 million of the debt of $843 million owed by EFGT to FGL was recoverable. He also recommended that the interest on the outstanding balance in each instance be reduced to nil. In substance, those recommendations as to write-offs were adopted. As well, in the 1999 financial year, Amayana wrote off as bad the entirety of the debt owed to it by EFGA apart from the assigned debts acquired by Amayana from EFG Financial; see [51]above. The write-off was said to be justified by the fact that any proceeds from the realisation of debts due to EFGA and its subsidiaries were to be applied in repayment of secured loans to EFGA from EFGT which, in turn, was obliged to use the repayments to it in reduction of its liabilities to FGL. 55 From September 1997, and during 1998, an allocation of repayments made by EFGS and ELFIC to EFGA, by EFGA to EFGT and by EFGT to FGL was undertaken on the basis that repayments specifically appropriated to a particular debt or loan should be applied in reduction or elimination of that debt or loan. Remaining payments attributed to interest were allocated to reduction of interest liabilities on a first-in first-out basis and any surplus was applied in reduction of unpaid principal and interest also on a first-in first-out basis. If any balance remained, that was also allocated to repayment again on a first-in first-out basis, of outstanding principal and unpaid interest. After that process had been completed, the balance (if any) assessed by Mr Neufeld as part of the "recoverable amount" was notionally applied, also on a first-in first-out basis, to reduction of the outstanding liabilities for principal and unpaid interest. 56 The interest charged by EFGA to ELFIC and EFGS, by EFGT and Amayana to EFGA, by FGL to EFGT and by FBGT to Amayana was treated as an expense in the profit and loss statements of each of the debtor companies. ELFIC and EFGS claimed deductions for the same interest from their assessable incomes and those deductions were included in the losses said to have been incurred by those companies which were transferred to other companies in the Foster's Group. 57 Similarly, EFGA claimed deductions for unpaid principal and interest due from ELFIC and EFGS which had been written off as bad debts. The unpaid interest component of those debts had previously been returned by EFGA as assessable income. EFGA also claimed deductions from its assessable income of liabilities for interest which it had incurred to Amayana. The combined deductions claimed by EFGA resulted in tax losses which were transferred to other companies in the Foster's Group. 58 EFGT and Amayana, in turn, claimed deductions for the interest charged on loans to them from FGL and FBGT. Having respectively included in their assessable incomes from 1992 to 1998 interest on loans made to EFGA, they claimed deductions in respect of the interest due from that company which had later been written off as bad. There was no claim for a deduction by either EFGT or Amayana of amounts of principal due from EFGA which had been written off as bad. However, the deductions claimed by EFGT and Amayana contributed to tax losses which were subsequently transferred to other companies within the Foster's Group. 59 Correspondingly, FGL had included in its assessable income from 1992 interest on loans which it had advanced to EFGT. It claimed a deduction in 1998 in respect of interest on those loans which had been written off as bad which contributed to another tax loss which was also transferred to another company within the Foster's Group. 60 The accounts for EFGT for the year ended 30 June 1996 recorded a loss of $1.1 billion resulting from a large provision for doubtful debts in relation to the receivables due from EFGA to reflect the likely level of recovery. In August 1996, the Board of EFGT agreed to make a provision for $1.12 billion and the Board of FGL provided further confirmation of its ongoing support. 61 To address the fact that all operating Finance Group entities had become net asset deficient by 31 October 1996, Lensworth Group Limited was established. On 26 March 1997, Lensworth Group acquired from EFGT the shares in the parent companies of the various land holding entities and late in that year the profits derived by Lensworth Group ceased to be reported as abnormal items and were disclosed as ordinary income of the Foster's Group on the basis that the property development activities by then constituted an ongoing business. 62 The Foster's Group continued to charge interest on the existing debts owed by the Finance Group even though the interest was extremely unlikely to be recovered. That course of action was justified on the basis that the realisation process was drawing to a close and the litigation risks appeared to have reduced with the settlement of several matters. 63 As at 30 June 1998, ELFIC owed EFGA debts totalling $1,294,441,115. On 19 June 1998, the $1,202,441,115 that ELFIC could not pay or repay EFGA was written off as bad, and the interest rate on the debts reduced to nil per cent per annum by the Board of EFGA with effect from 30 June 1998.

[130]

(a) The ELFIC/EFGA Bad Debt Deduction 83 EFGA claimed a deduction of $1,202,441,115 for the whole of the amount of debts due to it from ELFIC written off in the calculation of EFGA's taxable income for the 1998 year (the "ELFIC/EFGA Bad Debt Deduction"). Of the ELFIC/EFGA Bad Debt Deduction claimed by EFGA; (a) approximately $613,840,283 was unpaid interest that; (i) had accrued after 30 June 1991 on amounts owing by ELFIC to EFGA; (ii) had been included in the assessable income of EFGA; and (iii) was not able to be paid and was bad as at 30 June 1998. Deductions for these debts written off as bad were claimed pursuant to either s 25-35(1)(a) or s 8-1 of the 1997 Act; (b) approximately $80,875,985 was the balance of loans claimed to have been made by EFGA to ELFIC after 30 June 1991 in the ordinary course of EFGA's business of lending money that was not able to be repaid and was bad. Deductions for these debts written off as bad were claimed pursuant to either s 25-35(1)(b) or s 8-1 of the 1997 Act; and (c) approximately $507,724,847 was part of the amount that ELFIC owed EFGA as at 30 June 1991 that was not able to be paid or repaid and that was bad as at 30 June 1998 and represented either: (i) loans claimed to have been made by EFGA to ELFIC before 1 July 1991 in the ordinary course of EFGA's business of lending money; or (ii) interest that had accrued before 1 July 1991 on amounts owing by ELFIC to EFGA that had been included in the assessable income of EFGA. Deductions for these debts written off as bad were claimed pursuant to either s 25-35(1)(a) or (b) or s 8-1 of the 1997 Act. 84 It was submitted on behalf of EFGA that the outstanding loans which gave rise to the ELFIC/EFGA Bad Debt Deduction had been advanced by EFGA to ELFIC to facilitate and enhance collection of loans which had been made earlier by EFGA to ELFIC in the ordinary course of EFGA's business of lending money, and that, accordingly, the loss or outgoing incurred by writing off the amount of $1,202,441,115 was a loss or outgoing incurred by EFGA in the course of a business for the purpose of deriving assessable income.

[131]

(b) The EFGS/EFGA Bad Debt Deduction 85 As at 30 June 1998, EFGS owed EFGA debts totalling $106,009,231. On 19 June 1998, the $100,009,231 that EFGS could not pay or repay to EFGA was written off as bad, and the interest rate on the debts reduced by the Board of EFGA to nil per cent per annum with effect from 30 June 1998. 86 EFGA claimed a deduction of $100,009,231 for the whole of the amount written off in the calculation of its taxable income for the 1998 year (the "EFGS/EFGA Bad Debt Deduction"). Of the EFGS/EFGA Bad Debt Deduction claimed by EFGA: (a) approximately $51,814,703 was unpaid interest that; (i) had accrued on amounts owing by EFGS to EFGA; (ii) had been included in the assessable income of EFGA; and (iii) was not able to be paid and was bad as at 30 June 1998. Deductions for these debts written off as bad were claimed pursuant to either s 25-35(1)(a) or s 8-1 of the 1997 Act. (b) approximately $47,470,559 was the balance of loans claimed to have been made by EFGA to EFGS in the ordinary course of EFGA's business of lending money and which were not able to be repaid and therefore written-off as bad. Deductions for these debts written off as bad were claimed pursuant to either s 25-35(1)(b) or s 8-1 of the 1997 Act; and (c) approximately $723,969 was part of the amount which EFGS owed to EFGA and could not pay or repay. That amount was written-off as bad as at 30 June 1998 and represented either; (i) loans by EFGA to EFGS during the period 1 February 1991 and 31 March 1991 claimed to have been made in the ordinary course of EFGA's business of lending money; or (ii) interest that had accrued during the period 1 February 1991 to 31 March 1991 on amounts owing by EFGS to EFGA and had been included in the assessable income of EFGA. Deductions for these debts written off as bad were claimed pursuant to either s 25-35(1)(a) or (b) or s 8-1 of the ITAA 1997. 87 It was submitted that the outstanding loans which gave rise to the EFGS/EFGA Bad Debt Deduction had been advanced by EFGA to EFGS to facilitate and enhance collection of loans made earlier by EFGA to EFGS in the ordinary course of, EFGA's business of lending money, and that, accordingly, the loss or outgoing incurred by writing off the amount of $100,009,231 was a loss or outgoing incurred by EFGA in the course of a business for the purpose of deriving assessable income. 88 Seven of the companies in the Foster's Group claimed to have incurred tax losses in various tax years from 1996 to 1999 as a result of the transactions detailed in [88], [85] and [86] above. Those claimed losses can also be illustrated in tabular form as follows: Loss company Income year Amount of loss FGL 1998 $119,899,125 EFGT 1998 $525,437,631 Amayana 1999 $134,238,640 EFGA 1998 $1,299,477,144 ELFIC 1997 $87,255,934 EFGS 1996 $7,560,282

[133]

(i) EFGA's business before 1 January 1990 92 I am satisfied that, in performing its "treasury functions" for the Finance Group between 1986 and the end of 1989, EFGA operated analogously to a bank. It borrowed money from a variety of sources outside the Finance Group and on-lent the money so borrowed to ELFIC and EFGS (amongst others) at interest. It also lent money to external borrowers on the short term money market which was not immediately required to be deployed within the Foster's Group. As well, it accepted on deposit from entities within the Foster's Group, including ELFIC and EFGS, moneys which were surplus to the immediate business needs of those entities. It was acknowledged on behalf of the Commissioner that EFGA's activities in conducting a treasury operation were intended to yield a profit, but that intention, it was said, had to be evaluated in the context of EFGA's essential function which was to obtain debt funding "in a centralised fashion" for the benefit of other companies in the Finance Group which were themselves to carry on businesses of lending money. 93 Counsel for the Commissioner emphasised evidence in the form of contemporary documents dating from October 1984 including Board papers, statements of objectives, EFGA's operating charters and a request for stamp duty exemptions which make clear that the primary function of the company which became EFGA was conceived to be its establishment in the financial markets as a substantial centralised borrowing unit which could raise borrowed funds more cheaply and efficiently than individual entities within the Foster's Group. Another advantage of the interposition of a central treasury between operating entities of the Foster's Group and the sources of borrowed funds was seen to be the elimination of competition for funds between those entities in the external money market. It was considered that the benefit of the resultant savings could then be passed on to operating companies within the Foster's Group which would be on-lending to external customers the funds passed from the centralised borrowing unit, EFGA. 94 The Commissioner placed considerable emphasis on the fact that the margin above the cost to EFGA of externally borrowed funds which EFGA charged the operating entities, including ELFIC and EFGS, was "negligible" - of the order of 0.60%, which prompted certain executives in charge of the central treasury to express views to the effect that it was "illusory" to suggest that funding of internal entities made a profit for EFGA. Similar views were expressed to the effect that "funding" would always lose money. Reference was made additionally, in the same context, to the absence of any separate accounting within EFGA of the income derived from on-lending within the Foster's Group as distinct from the income derived from loans on the short-term money market to external parties. Although management accounts and budgets showed the difference between the cost of funds and interest earned from on-lending those funds, that difference was negligible in amount having regard to the "massive" sums which were on-lent to the internal entities. As well, the Commissioner pointed to the absence of any allowance in the management accounts or budgets by way of provision for bad or doubtful debts or otherwise in respect of the risk of non-repayment by one or other of the internal entities and the failure to attempt any "rigorous measurement" of EFGA's revenue relative to its expenses. 95 A related consideration was said to be the fact that EFGA's massive on-lending to ELFIC and EFGS between 1987 and 1989 was maintained in the face of slender and diminishing ratios of assets to liabilities of each of those members of the Foster's Group. It was no answer to that consideration, the Commissioner argued, that any inability by ELFIC or EFGS to repay principal or pay interest on borrowed funds could be rectified by an injection of capital by EFGA. 96 Counsel for the Commissioner also contended that the evidence suggested that the primary function of the attribution or identification of a "profit" within the management accounts of EFGA was as a crude measurement of performance by treasury staff and a basis for rewarding them with bonuses. 97 The Commissioner contrasted the "unbusinesslike" approach of EFGA to loans to ELFIC and EFGS as internal entities with the controls and protocols imposed on the lending by those companies to external customers. It was suggested that no prudential limits, terms of lending or security requirement were imposed in respect of loans by EFGA to entities within the Foster's Group so as to reflect the borrowers' "weak and deteriorating balance sheets." Also indicative of a similar lack of businesslike concern with the risk of lending was said to be the absence of any adjustment from time to time of the rate of interest charged to internal borrowers by reference to the degree of risk. Rather, the rate was set by agreement between EFGA and the borrowing entity having regard to the rate at which the borrower would, itself, have been able to obtain funds on the open market. 98 It was also pointed out on behalf of the Commissioner that the margin of 0.60% charged to internal borrowers within the Foster's Group was not a mark-up or margin on top of the cost to EFGA of the borrowed funds. Rather, it was added to the 90-day BBR and represented, after allowing for expenses, only a minuscule total addition to the amounts advanced. It represented, on the Commissioner's case, no more than a "break-even" target or even less when account was taken of the revenue derived by EFGA from loans to non-related parties. These factors, in combination, were said to provide a strong contra-indication of engagement by EFGA in a "business of lending money." 99 EFGA's involvement in making loans to external borrowers on the short-term money market was said not to be available to support its engagement in a business of lending money because that activity was purely ancillary to the making of loans to entities within the Foster's Group. It would not have occurred but for EFGA's central treasury function and was part of active management, in the role of an arbitrageur, of borrowing and interest rate fluctuations.

[134]

(ii) Did EFGA conduct a business of lending money during the wind-up period? 100 In pressing for a negative answer to this alternative question, the Commissioner pointed to the fact that all of the principal advanced, and interest charged to ELFIC, which was written off as a bad debt by EFGA, had been advanced after 30 June 1990. A similar conclusion was available in respect of most of the principal and interest payable by EFGS which had been written off. 101 After June 1990, EFGA radically changed the nature of its business. It ceased to borrow funds from external lenders and looked, instead, to lenders within the Foster's Group. It conducted its activities through RAMCO for the benefit of the Foster's Group as a whole, rather than of EFGA's own business. Consistently with that change, it ceased lending to make a profit. That was done by eliminating, from 1 September 1990, the inter-entity interest rate margin, including that charged to ELFIC and EFGS. The Finance Group's treasury business, other than the funding of internal entities, was sold on 31 January 1990 to the Dresdner Bank. That change of course by EFGA was said to be consistent with an announcement by the Foster's Group, on 8 March 1990, that it would concentrate on its brewing business and divest itself of all its other businesses. From then on, EFGA focused on selling assets and recovering loans which it had made to external borrowers. Although EFGA's assets had been reduced from $5.9 billion at 30 June 1989 to $2.7 billion at 30 June 1990, its assets realisation program was slowed by the deepening recession to a point where it was estimated, in February 1992, as likely to take from five to seven years to complete. Part of that projection reflected a decision to maximise the value of certain real properties which had been acquired from the Emanuel Group by re-zoning and developing the land which was recognised as requiring to be done over an extended time. 102 Although new loans were made during the wind-up period by EFGA to internal borrowing entities, they were made to enable those entities to continue to meet obligations to external third parties from which a discharge could not be negotiated or to enhance the borrowing entities' prospects of recovering debts from third parties. 103 RAMCO's activities during the wind-up period were conducted for the benefit of the Foster's Group as a whole and not solely for the benefit of EFGA. This was illustrated by RAMCO's assumption of management of the Lensworth Group and the establishment of Lensworth Group Limited as a direct subsidiary of FGL rather than as a subsidiary of EFGA. 104 In contending that the loans to ELFIC and EFGS were not made in the ordinary course of EFGA's business of lending money, the Commissioner submitted that the loans were not advanced "with a view to making any real economic return" or "commercial profit" from the internal borrowers. Rather, they were made as a cheap and efficient provision of funds to the borrowing entities which, themselves, carried on businesses of lending money. EFGA's placement of surplus funds on the short-term money market was characterised as "minimising liquidity risk" and "hedging against interest rate and foreign exchange risks." 105 It followed, according to the Commissioner, that the loans to ELFIC and EFGS had been made as part of a commercial activity of EFGA which was not a discrete business of lending money. When EFGA's activities are analysed in the way required by Fairway Estates Pty Ltd v Federal Commissioner of Taxation (1970) 123 CLR 153, there could not be imputed to EFGA an intention to carry on the business of lending money along with other activities. In Fairway Estates, Barwick CJ observed, at 163; 'The appellant was incorporated to carry on the business of the lending of money along with other activities. This, I am satisfied was an actual intention of its subscribers and not merely a precautionary inclusion of an object in its memorandum along with a large number of other possible courses of action. The appellant's association with United, having regard to the activities and financial resources of that company, confirms the view that the appellant intended throughout to carry on the business of the lending of money as opportunity offered.'

[135]

106 The absence of any such intention by those responsible for the incorporation and management of EFGA was said to be confirmed by the concentration in public statements on its role as a large and credible borrower in the global money market and its focus on efficient management of the Foster's Group's exposure to liquidity, currency and interest rate fluctuations. There was no express reference in the various operating charters formulated for EFGA to its carrying on a business of lending money. Nor did EFGA exhibit the systematic and continuous conduct of a commercial activity "capable of being described as, in effect, business operations intended to yield a profit"; see Richard Walter Pty Ltd v Commissioner of Taxation (1995)95 ATC 4440 per Tamberlin J at 4458. 107 The Commissioner also pointed to the fact that EFGA had a relatively low level of equity of its own and derived its borrowing capacity from its position as the holding company of the Finance Group supported by cross-guarantees from companies within the Group and from the ultimate parent company. As well, the Commissioner relied on what was said to be a lack of relevant skills and expertise among EFGA's executives in the conduct of a business of lending money. Those qualifications were argued to include experience and capacity in assessing the creditworthiness of borrowers and in managing the risks of a portfolio of loans. The skills of the relevant personnel was said to be confined to the performance of treasury functions. In a related way, the Commissioner instanced the absence of limits on lending to a particular internal entity, of the assessment of creditworthiness of the borrowers and of the application of other techniques of risk management. Those features were explained as reflecting the fact that EFGA made its loans to internal entities at the direction of FGL, "the ultimate holding company of the wider Foster's Group." 108 Those features of the arrangements between EFGA and the internal borrowing entities were said to be similar to those in Hungier v Grace (1972) 127 CLR 210 where the borrower proposed the period of the loan and the rate which, irrespective of that period, was to be paid by way of interest. As to those arrangements, Walsh J said, at 225; …seem[] to me to be so greatly at variance with the manner in which I should expect a person to carry on a business of money-lending that it becomes very difficult to affirm that the appellant was carrying on that business.

[140]

(d) EFGA's contentions as to its bad debt deductions 113 It was submitted on behalf of EFGA that the debts owed to EFGA by ELFIC and EFGS which had been written off were deductible under s 25-35(1) of the 1997 Act. According to that submission, the moneys had actually been advanced with the intention that principal would be repaid and interest would accrue and be paid. Moreover, such repayments and payments were actually made but not to the full extent of the principal advanced and interest accrued. 114 In relation to the requirement imposed by s 25-35(1)(b) of the 1997 Act, it was contended on behalf of EFGA that it had, between 1986 and 1998, carried on a substantial business of lending money. The nature of that business did not materially change during the "wind down" or orderly realisation of the assets of the Finance Group. Even during that period, EFGA continued to make new advances as well as receiving repayments of principal and payments of interest in respect of existing loans. 115 The debts from ELFIC and EFGS which had been written off were in respect of advances made to those companies before and after March 1990. 116 It was submitted, in the alternative, on behalf of EFGA that the principal and interest components of the debts which had been written off were deductible under s 8-1 of the 1997 Act. It was said that the debts which had been written off were a product of the carrying on of EFGA's business of borrowing and lending and the loans which gave rise to the bad debts were part of a collection of such funds which had been used to produce assessable income. Neither the principal nor the interest component of the relevant bad debts, according to EFGA, had constituted a loss of capital or of a capital nature. Rather, the loan funds were "circulating capital" in the sense used by Kitto J in National Bank of Australasia Ltd v Federal Commissioner of Taxation (1969) 118 CLR 529, at 537 so that the loss was on revenue account. 117 Counsel for EFGA contended, in the further alternative, that, if the interest and principal written off as bad debts were not wholly deductible, at least the interest component of each such debt was deductible under either s 8-1 or s 25-35(1). The latter sub-section was said to be applicable to the interest component of each bad debt because the interest had been returned as part of EFGA's assessable income in a previous year.

[142]

121 Similarly, I do not regard as significant in characterising the ordinary course of EFGA's business the fact that benefits other than the derivation of a profit were perceived as likely to flow from the conduct of that business. The failure to make provision in EFGA's accounts for bad or doubtful debts owed by borrowers within the Foster's Group was explicable by the common enterprise in which the Group was engaged and the fact that there were no separate shareholders who might look to individual subsidiaries, including EFGA, for a dividend. Similar considerations explain the maintenance between 1987 and 1989 of high levels of advances to ELFIC and EFGS notwithstanding the diminishing individual creditworthiness of those subsidiaries. 122 It is not to the point, in my view, that an activity has been carried on in an "unbusinesslike" or inefficient manner. The distinction as McCardie J suggested in Edgelow v MacElwee, supra, at 206 is between loans to relations, friends or acquaintances or otherwise on an occasional and disconnected basis and loans made with the requisite degree of system and continuity to import the carrying on of a business. On this analysis, I have concluded that EFGA before 1990 lent money to ELFIC and EFGS in the ordinary course of EFGA's business of lending money. 123 Nor have I been able to conclude that the activities of EFGA during the wind-up period were otherwise than in the ordinary course of its business of lending money. It is true that during that period EFGA ceased to charge the previous inter-entity rate of interest on loans to Finance Group borrowers but that was merely in recognition of the precarious financial states of those subsidiaries and the need for EFGA to make its own contribution to a quick and effective realisation of group assets. There was, I consider, an actual and continuing intention by those managing EFGA to carry on during the wind-up period its business of lending money although the carrying on of the same business was directed to a different end or purpose. In that sense the intention of those controlling EFGA during the wind-up period coincided with that regarded by Barwick CJ in Faraway Estates Pty Ltd v Federal Commissioner of Taxation (1970), supra, at 163, as satisfying the relevant test. 124 That EFGA carried on its activities during the wind-up period at the direction of others, including, ultimately, FGL does not entail that it ceased during that period to carry on its former business of lending money. It was merely directed to carry on the same business for different purposes which included the winding up of its own business at the core of which was the lending of money, the recovery of principal advanced and accrued interest thereon. The leaving of funds with ELFIC and EFGS was still a mode of employing those assets in the sense suggested by Brennan J in Northern Engineering Pty Ltd v Federal Commissioner of Taxation (1979) 42 FLR 301, at 304. The employment during the wind-up period of funds advanced to ELFIC and EFGS was not profitable for EFGA as it had been before 1990 but that does not entail that a change occurred in the character of the business pursuant to which the funds had been advanced. Nor, contrary to the Commissioner's submission, did it entail that the loans to ELFIC and EFGS after 1990 were no longer advanced in the ordinary course of lending money. 125 For these reasons I have been led to conclude that the principal and interest owed to EFGA by ELFIC and EFGS which had been written off were deductible under s 25-35(1) of the 1997 Act. I am reinforced in that conclusion by the fact that, throughout the relationship of creditor and debtor, moneys were actually advanced to ELFIC and EFGS and in part repaid by them together accrued interest, albeit not the full amount of such interest. 126 In light of the conclusions which I have just reached, it is unnecessary to consider the alternative submission advanced on behalf of EFGA, that the debts owed by ELFIC and EFGS which were written off as bad were wholly or partly deductible under s 8-1 of the 1997 Act.

[143]

(iii) EFGT's Bad Debt Deductions 127 EFGT's claimed deduction included a debt of $525,260.13 representing unpaid interest written off as bad which had been owed to it by EFGA. Submissions similar to those for EFGA were advanced in support of this claim to a deduction by EFGT. The bad debts were said to be deductible under s 25-35(1)(a) or, alternatively, under s 8-1 of the 1997 Act. 128 It will be recalled that EFGT became the conduit for loan funds provided under a Security Note by the Foster's Group to EFGA as part of the security structure erected in 1991 as described at [41] of these reasons. The loans from EFGT to EFGA were made at interest and EFGT in turn paid interest under the Security Note facility at a rate of 1.5% above the 90 day BBR. Further advances were made by the Foster's Group to EFGT after October 1991 and a further Security Note for $0.5 billion was executed in respect of those further advances in August 1992. The further funds were on-lent by EFGT to EFGA which continued to be charged interest to the end of the 1998 financial year. EFGT similarly continued to be charged interest during the same period on the further funds advanced to it by the Foster's Group. EFGT also accepted, in addition to the funds borrowed under the security structure, moneys on deposit from other members of the Finance Group and incurred a liability for interest on those deposits. In each year from 1993, except 1996 and 1997, EFGT made substantial operating profits from its activities. However, in 1996, it recorded a massive operating loss of $1,119,511,434 and in the following year a smaller, but still significant, operating loss of $1,284,849. In the same period its total reported expenditure by way of interest was almost identical in each year to its reported income in the form of interest. The greater part of that interest in each year appears to have been incurred on borrowings from FGL. 129 In opposing EFGT's claim to a deduction to the bad debt written off in respect of the interest due from EFGA, the Commissioner relied on the submissions, so far as applicable, which he had advanced in respect of the claim by EFGA for a bad debts deduction. He also relied generally on certain factual conclusions that were said to be available in relation to the capacity of ELFIC, EFGS, EFGA, EFGT and Amayana to pay interest and principal on their inter-company loans. In the first place, it was pointed out that each of the loans was repayable at call. As indicative of the straitened circumstances of companies within the Finance Group, the Commissioner pointed to the fact that, in May and June 1990, the directors of the Finance Group had sought a letter of comfort from FGL and had only been prepared to sign the solvency statements in the statutory accounts of members of the Finance Group after FGL, on 20 June 1990, passed a resolution that FGL would support the subsidiaries. A letter dated 6 July 1990 from BHP was said to indicate a belief by that company that loans by FGL to Finance Group subsidiaries would be repaid. 130 Other indications from the evidence were relied on as tending to establish that, during 1990, EFGA, EFGS and ELFIC had, or were likely to have, a net deficiency of assets and from 31 December 1990, EFGA "had begun to suffer a deficit" of $13 million in shareholders' funds. One of the consequences was that Amayana would not be able fully to recover its receivables from EFGA. 131 The Commissioner also relied heavily on a report by Mr Meredith, a financial analyst, who demonstrated that, in the year ended 30 June 1990, ELFIC's available assets totalled $522 million whereas its liability to EFGA in respect of principal and interest amounted to $992 million. The discrepancy widened in subsequent years to a point where, by 30 June 1997, ELFIC had no available assets from which to make repayments. A similar deteriorating pattern of incapacity to pay obtained in respect of EFGS. In consequence, by 30 June 1997, EFGA's capacity to repay principal and interest on loans to it from Amayana had been reduced to 11% of the total liability. 132 Mr Meredith's approach to assessing EFGA's capacity to pay was defended by the Commissioner as reflecting realistic prospects of recovering loans from subsidiaries as discernible from their statutory accounts rather than having regard to provisions made by EFGA for loans which were not fully recoverable. Those provisions were characterised by the Commissioner as mere "balancing items" which provided no true guide to the recoverability of loans made by EFGA to ELFIC and EFGS. 133 Counsel for the Commissioner also discounted the applicants' contention that Mr Meredith's approach failed to take account of the possibility that assets disclosed by the statutory accounts might be realised for more than their book values. It was pointed out that the assets comprised loans of fixed amounts and, in any event, were realisable for the benefit of FGL rather than the Finance Group. 134 Another issue raised by Mr Meredith's evidence centred on his assumption that two loans to EFGA by internal entities, EFGT and Amayana, ranked equally. Although EFGT held security over EFGA's assets and Amayana did not, the Commissioner contended that the security granted to EFGT was merely a device to defeat external creditors. In support of this contention, the Commissioner instanced the fact that FGL did not exercise its powers under a charge from ELFIC despite the occurrence of a "trigger" event, namely ELFIC's having become unable to pay its debts as and when they fell due. The Commissioner also pointed to EFGA's having made repayments under the loan to it from Amayana despite the fact that the much larger loan from EFGT remained outstanding. 135 In further reliance on Mr Meredith's evidence, the Commissioner claimed that, between July 1990 and July 1998, Amayana lacked the capacity to repay in full money which it had borrowed from FBGTA and on-lent to EFGA. Over the period in question, on Mr Meredith's analysis, Amayana's capacity to meet its liability to FBGTA had declined from 41% of the loan balance to only 11%. A similar analysis led Mr Meredith to conclude that, between 1992 and the financial year ending on 30 June 1996, EFGT's capacity to repay to FGL moneys which EFGT had on-lent to EFGA had declined from about 25% to a mere 1%. The difference between Mr Meredith's analysis and the statutory accounts of Amayana and EFGT, according to the Commissioner, was explicable by the fact that EFGT did not raise provisions against its assets until the financial year ended 30 June 1996 when it raised a provision of $1,120,000,000 and Amayana never raised such a provision but allowed its net assets to be recorded as represented by its paid-up capital of $2. 136 In the light of the matters to which he drew attention, the Commissioner invited the conclusion that, from early to mid 1990, the Finance Group was unable to pay its debts as and when they fell due and that, without FGL's support, external lenders would have refused further credit and have begun calling up existing debt as it became enforceable, thereby forcing the companies in the Finance Group into liquidation. 137 On the Commissioner's analysis, the "real loss" between 1991 and 1998 was incurred by ELFIC and EFGS when loans which they had made in the course of their respective money lending businesses proved irrecoverable. As a result, ELFIC and EFGS were unable to pay interest or repay capital on loans made directly or indirectly to them by other companies within the Foster's Group. This inability was at all times known to those directing the affairs of the Foster's Group who, nevertheless, continued, until 1998, to make inter-group loans and to allow accrued interest to be capitalised. 138 The Commissioner also claimed that the "tax loss", presumably of the Foster's Group as a whole, had been "magnified" because each company in the funding chain had been able to write-off amounts for internally generated debts in the form of interest which had not been paid. That "magnifying" effect was also said to have been compounded by the delay, until 1998, in writing off the debts and ceasing to debit the borrowing companies with further instalments of interest. 139 On the assumption that each relevant taxpayer had not been carrying on a business of lending money, the Commissioner disputed that s 25-35(1)(a) of the 1997 Act had any application to the debts in respect of unpaid interest. That provision, it will be recalled, is in these terms; You can deduct a debt (or part of a debt) that you write off as bad in the income year if:

[145]

140 Two reasons were advanced by the Commissioner against the deductibility under s 25-35(1)(a) of the write-offs in question. In the first place, it was contended that there was no reasonable prospect that the interest returned as assessable income by creditor companies would be received. That was because EFGA lacked capacity to pay interest from time to time because of the inability of ELFIC and EFGS to recover enough under the loans due to them to reimburse EFGA in respect of advances respectively made to ELFIC and EFGS. In this context, the Commissioner relied on Permanent Trustee Co (Executors of F H Prior dec) v Federal Commissioner of Taxation (1940) 6 ATD 5, Cross (Inspector of Taxes) v London & Provincial Trust Ltd [1938] 1 KB 792 and Henderson v Federal Commissioner of Taxation (1969) 119 CLR 612 per Windeyer J, at 637. 141 The second proposition on which the Commissioner relied in this context was that interest recognised as having accrued is not derived for tax purposes until it has been received. In the present case, there was no "coming home" or "coming in" to the taxpayer in a realisable form of an amount representing interest on the loans in question; cp, The Commissioner of Taxation (SA) v The Executor Trustee and Agency Company of SA Limited (1938) 63 CLR 108 and St Lucia Usines & Estates Co Ltd v Colonial Treasurer of St Lucia [1924] AC 508, at 512. 142 The Commissioner accepted that taxpayers who carry on a business of lending money are excepted from the general rule that interest is only assessable when received and are obliged to return interest as income as it accrues. However, this exception was said to be available, even arguably, only to EFGA which, for the reasons summarised at [104]-[110] above, was not engaged in a business of lending money. It followed, according to the Commissioner, that it is not open to a taxpayer to invoke s 25-35(1)(a) in consequence of a mistaken return of interest as income in a given year. An assessment giving effect to a mistaken return of that kind in a given year should be amended and any claim to write off as a bad debt the interest so returned should be disallowed. 143 An alternative contention advanced on behalf of the Commissioner was that the amount of the deduction available under s 8-1 of the 1997 Act is limited to the loss suffered by the taxpayer. It was said that the debts in the form of unpaid interest written off by EFGA, EFGT and FGL as at 30 June 1998 and by Amayana in July 1998, did not give rise to any loss for the purposes of s 8-1 because the receivables were valueless when brought to account. Support for this proposition was said to be derived from J Rowe & Son Pty Ltd v Federal Commissioner of Taxation (1970-71) 124 CLR 421 and BHP Billiton Petroleum (Bass Strait) Pty Ltd v Commissioner of Taxation (2002) 126 FCR 119, at 140 [80]. In a related way it was argued that the creditor companies did not incur the losses in gaining or producing income because there was never a realistic prospect of receiving more than a negligible amount of the interest accruing from time to time. Any payment of interest would have affected detrimentally the ability of the debtor companies to make repayments of capital. 144 A further alternative argument advanced on behalf of the Commissioner was that, if the creditor companies did suffer losses to the extent of the bad debts written off, those losses were of a capital nature and not allowable under s 8-2 of the 1997 Act. The losses were unrelated to the income-producing activities of any of FGL, EFGT, Amayana or EFGA because each advance was made after the relevant borrowing entity had become insolvent. The loans were made to ensure the survival of companies in the Finance Group and ensure the orderly realisation of the assets of those companies, thereby preventing the failure of the Foster's Group as a whole. There was never any prospect that the debtor companies would pay interest or dividends. Reference was made to North Australia Pastoral Co Ltd v Federal Commissioner of Taxation (1944) 71 CLR 623, at 635 and Odhams Press v Cook [1940] 3 All ER 15, and a comparison was invited with Federal Commissioner of Taxation v Total Holdings (Aust) Pty Ltd (1979) 24 ALR 401.

[146]

Consideration of EFGT's bad debt deductions 145 For the reasons explained in relation to EFGA, I have concluded that the principal and interest owed to EFGT by EFGA was money lent by EFGT in the ordinary course of its business of lending money. EFGT had itself borrowed that money and incurred interest expenses in doing so. Except in 1996 and 1997, its business of lending money to EFGA and, through it, to other members of the Finance Group had been profitable. The fact that borrower companies found themselves in financial difficulties between 1990 and 1998 does not detract from the conclusion that the continuing provision of debt finance to those companies to enable them to trade out of their difficulties was in the ordinary course of a business of lending money. 146 It is true that decisions could have been made earlier than they were to write-off the bad debts in question or to cease to charge interest to the borrowing companies. However, those were matters calling for the exercise of commercial judgment. In the present case that judgment was coloured by a view of the time needed to recover the debts and the extent to which they were recoverable, which proved unduly optimistic. However, the fact with hindsight the decisions which were made can be regarded as ill-advised, cannot affect the deductibility of the debts under s 25-35(1)(b) of the 1997 Act. 147 I do not regard the necessity for several companies within the Foster's Group to have written off bad debts owed by other companies within the Group as having the "magnifying" effect for which the Commissioner contended. Each debt had actually been incurred and each of the relevant debtors had made substantial repayments of principal and payments of interest in respect of its indebtedness. It was therefore available to be written off by the entity in the Foster's Group to which it was owed. 148 The conclusion which I have reached in relation to EFGT's bad debt deductions makes it unnecessary to consider, in respect of that taxpayer, the Commissioner's further contentions about the application to that taxpayer of s 25-35(1)(a) or s 8-1 of the 1997 Act.

[147]

(iv) FGL's Bad Debt Deductions 149 The Commissioner disallowed a deduction claimed by FGL in respect of the 1998 year of income for bad debts written off in that year and constituted by unpaid interest and outstanding principal referable to loans made by FGL to EFGT. The bad debts written off totalled $634,220,249 of which the interest component had been included in FGL's assessable income in each year in which interest had accrued. The accounts of the consolidated Foster's Group of which FGL was the listed parent company reveal that FGL and the consolidated Foster's Group made substantial operating profits in each year from 1989 to 1998 except for 1992 when FGL had an operating loss of $949,439,000 and the consolidated Foster's Group had an operating loss of $949,385,000. FGL's operating revenues over the same period included in each year a significant component of interest which was returned in FGL's assessable income. 150 Initially, intra-group loans were made by FGL at interest directly and indirectly to EFGA. The indirect loans were made by way of advances to AML Finance which were then on-lent to EFGA. After the erection of the security structure noted at [41] above, AML Finance's loans to EFGA were replaced by loans from FGL to EFGT and thence to EFGA. Those loans continued to accrue interest which, from that time, was at the 90 day BBR plus 1.5%. 151 EFGT made substantial payments of interest and repayments of principal to FGL between 1992 and 1998. It also made further such payments in excess of $61 million between 1999 and 2001. 152 The Commissioner impliedly accepted that FGL had never carried on a business of lending money and otherwise relied on the contentions which I have already summarised as denying the deductibility under either s 25-35(1)(a) or s 8-1 of the 1997 Act of the bad debts written off by FGL. 153 In respect of FGL's claim for the bad debt deductions, Counsel for the taxpayers advanced submissions essentially similar to those addressed to the corresponding claim for a deduction by EFGA. However, as an alternative to a claim for the deduction under s 25-35(1)(a) of the 1997 Act for the whole of the debts written off as bad, it was argued that the interest component of those debts was deductible under s 8-1 of the 1997 Act because that component was not capital or of a capital nature; The characteristic of the loss or outgoing is determined by the nature of what was written off. The interest arose daily on the outstanding amounts owed to EFGT by EFGA. It follows that the writing off of bad debts in respect of interest was a loss or outgoing of a revenue nature.

[148]

Consideration of FGL's Bad Debt Deduction 154 In my view the bad debts written off by FGL in respect of the debts due to it from EFGT were deductible under s 25-35(1)(a) or alternatively under s 801 of the 1997 Act but only to the extent that those debts contained a component representing unpaid interest. It cannot be suggested that FGL was engaged in a business of lending money. Its business, the evidence indicates, was that of a holding company. It is apparently not disputed that it included as part of the assessable income derived from that business in previous years the interest charged to EFGT. The evident policy which I discern as underlying s 25-35(1)(a) is that a taxpayer who returns as income in one year an amount earned or derived but not received, is entitled to deduct from the assessable income for a later year that amount if it is not received but is written-off in the later year. I accept that the mistaken inclusion of an amount as income in an earlier year cannot support a deduction of the amount so included in a later year. As Hill and Heerey JJ observed in BHP Billiton Petroleum (Bass Strait) Pty Ltd v Commissioner of Taxation (2002) 126 FCR 119, at 140 [80]; Then there is the question whether the taxpayer would be entitled to a deduction under s 63 of the Act should it turn out that the taxpayer was not owed the amount claimed and which has been included in assessable income. Under the law as presently interpreted it would seem that the taxpayer could not. No deduction is available under s 63 if, at the time of write-off, there is actually no debt owed as might be said to be the case in the event that the taxpayer's claim to the invoiced amount was unsuccessful: GE Crane Sales Pty Ltd v Commissioner of Taxation (Cth) (1971) 126 CLR 177, Point v Commissioner of Taxation (Cth) (1970) 119 CLR 453, Franklin's Selfserve Pty Ltd v Commissioner of Taxation (Cth) (1970) 125 CLR 52. There might, for the same reason, be no ability of a taxpayer to obtain a deduction under s 51(1) of the Act, because the taxpayer would have incurred no loss if it should turn out that the taxpayer was never owed the amount claimed. While both ss 63 and 51(1) have been repealed and replaced in the Income Tax Assessment Act 1997 (Cth) by ss 25-35 and 8-1 respectively, the problem averted to has not been the subject of legislative intervention.

[150]

(v) Amayana's Bad Debt Deductions 156 It was contended on behalf of Amayana that the interest component of the bad debts written off in the 1999 year of income was deductible from Amayana's assessable income for that year under s 25-35(1)(a), or alternatively under s 8-1, of the 1997 Act. In this context, Counsel for Amayana invoked essentially the same contentions as had been advanced on behalf of FGL. 157 The Commissioner relied, in relation to Amayana, on essentially the same contentions as he had advanced against the deductibility of the bad debts written off by EFGA, EFGT and FGL. As with FGL, the Commissioner did not have to meet an argument that the bad debts written off by Amayana had been in respect of money which it had lent in the ordinary course of a business of lending money. However, the Commissioner also raised an additional argument based on the application to the whole of the debt for principal and interest due to Amayana from EFGT which was written off. According to the Commissioner, neither amount should have been recognised as a receivable in Amayana's accounts and so there was no debt in respect of unpaid interest which could have been written off as bad by Amayana. 158 Alternatively, the Commissioner contended that Div 245 of Sch C of the 1936 Act applied to the whole debt constituted by unpaid principal and interest written off by Amayana. In the result, the loss suffered by EFGA would be reduced by $200,241,963 and that suffered by EFGT by $83,384,542. 159 A "debt" is defined by s 245-15 of Sch 2C as "an enforceable obligation imposed by law on a person to pay an amount." Division 245 characterises a debt as a "commercial debt" if interest payable on it is, or would be, allowed as a deduction to the debtor. If, contrary to the Commissioner's primary contention, it be held that the unpaid interest owed by EFGA to Amayana is deductible, then the debt becomes a "commercial debt" as defined in s 245-25. That commercial debt, the Commissioner contended, was forgiven in the sense that, when it was written-off, it was "released, waived or otherwise extinguished" within the meaning of s 245-35. The Commissioner calculated the "gross forgiven amount" of the debt due from EFGA to Amayana in accordance with s 245-55 as $325,088,518 and because none of the amounts specified in s 245-85(1) was available to reduce the amount of EFGA's debt the net forgiven amount of that debt was said to be $323,678,521.

[153]

162 In urging that those deductions were not available to the respective borrowers, the Commissioner again pointed to the extreme unlikelihood, after 1990, that any of the borrowing companies would be able to pay all, or even most, of the interest on their borrowings. That incapacity, it was said, was self-evident and compelled the conclusion that the earning of interest from the debtor companies was not a genuine concern of those in the Foster's Group involved in managing the affairs of the taxpayer companies. The focus was, rather, on the external assets and the ability of the whole Foster's Group to survive. These inferences were said to be reinforced by a request made of FGL in 1991 for $400 million in interest-free funding for EFGA which, it was recognised, would have "no impact on the liquidity of the Group …. [as] …. all of the entries associated with it would have been eliminated on consolidation." Accordingly, there was no purpose of earning interest on the loans to internal entities. 163 Alternatively, because everything done after March 1990 in relation to those loans was done with a view to preserving the viability of the Foster's Group as a whole, liability for interest incurred at various points in the internal chain should be treated as of capital account. 164 The Commissioner accepted that s 51(1) of the 1936 Act (applicable to the income years ended 30 June 1995, 1996 and 1997) and s 8-1 of the 1997 Act (applicable to the income year ended 30 June 1998) were not materially different in operation or effect. It was pointed out that each of FGL, EFGT, Amayana and EFGA had returned the unpaid interest as assessable income in each income year in question and had claimed as deductions the interest costs incurred in advancing the sums. The result in each case was said to be "tax neutral" until each taxpayer company wrote off as bad debts the amounts of unpaid interest and claimed tax deductions in respect of the amounts so written off. 165 ELFIC and EFGS each claimed as deductions the interest expenses which they had incurred on loans from internal creditor companies but, as the Commissioner pointed out, those interest expenses were disproportionately greater than the income which each of ELFIC and EFGS derived from external customers, particularly from 1990 when ELFIC and EFGS were in "wind down mode" with no prospect of meeting their liabilities for interest. This feature of the case was said to attract the application of the principle enunciated in these terms in Fletcher v Federal Commissioner of Taxation (1991) 173 CLR 1, at 18-19; The position may, however, well be different in a case where no relevant assessable income can be identified or where the relevant assessable income is less than the amount of the outgoing. Even in a case where some assessable income is derived as a result of the outgoing, the disproportion between the detriment of the outgoing and the benefit of the income may give rise to a need to resolve the problem of characterization of the outgoing for the purposes of the sub-section by a weighing of the various aspects of the whole set of circumstances, including direct and indirect objects and advantages which the taxpayer sought in making the outgoing [See, eg, Robert G Nall Ltd v Federal Commissioner of Taxation (1937), 57 CLR 695, at pp 699-700, 706, 708-709, 712-713]. Where that is so, it is a "commonsense" or "practical" weighing of all the factors which must provide the ultimate answer [[See, eg, BP Australia Ltd v Federal Commissioner of Taxation (1965), 112 CLR 386, at pp 396-397; [1966] AC 224, at p 264; Hallstroms Pty Ltd v Federal Commissioner of Taxation (1946), 72 CLR 634, at p 648; Federal Commissioner of Taxation v Foxwood (Tolga) Pty Ltd (1981), 147 CLR 278, at pp 285, 293]. If, upon consideration of all those factors, it appears that, notwithstanding the disproportion between outgoing and income, the whole outgoing is properly to be characterized as genuinely and not colourably incurred in gaining or producing assessable income, the entire outgoing will fall within the first limb of s 51(1) unless it is either somehow excluded by the exception of "outgoings of capital, or of a capital, private or domestic nature" or "incurred in relation to the gaining or production of exempt income". If, however, that consideration reveals that the disproportion between outgoing and relevant assessable income is essentially to be explained by reference to the independent pursuit of some other objective and that part only of the outgoing can be characterized by reference to the actual or expected production of assessable income, apportionment of the outgoing between the pursuit of assessable income and the pursuit of that other objective will be necessary.

[155]

168 The same approach, the Commissioner argued, precludes the Court in this case from concluding that the whole of the claims for interest can properly be characterised as "genuinely and not colourably incurred in gaining or producing assessable income." The real purpose of each entity in incurring the relevant interest expense was in preserving the overall financial viability of the Foster's Group as a whole and was focused on its overall assets and liabilities insofar as they might affect the actions of external creditors in relation to FGL as an unsecured creditor of companies within the Finance Group. There was no real concern with income earning activities of "the individual entities involved in the funding structure." 169 It was said in the same context that the charging of interest ultimately for the benefit of FGL allowed it to take full advantage of the dividend rebate on dividends flowing to it from within the Finance Group; cp Spassked Pty Ltd v Federal Commissioner of Taxation (No 5) (2003) 197 ALR 553, at 561-2 [31], [32]. 170 Another feature of the altered funding arrangements between 1990 and 1991 was that FGL effectively became the financier of the Finance Group and passed the cost of assuming this role, by charging interest on its loans, first to EFGA and later to EFGT which relayed the interest costs to EFGA. The Commissioner acknowledged that this arrangement "notionally balanced out" the additional cost to FGL of funding the Finance Group; cp, Macquarie Finance Ltd v Commissioner of Taxation (2005) 146 FCR 77 where it was held by French J, who was in the majority in the result, that interest payable by a subsidiary (MFL) to holders of notes stapled to preference shares in the parent company (MBL) was not deductible under s 8-1(1) because MBL had a capacity to redirect interest payments to MBL so that they would be received as dividends on the preference shares instead of interest on the notes. French J was persuaded to come to that conclusion because MFL's liability to pay interest on the notes was not tied to any income-producing purposes of its own but was incurred to procure a permanent capital increase for MBL's corporate group to satisfy capital adequacy requirements imposed by the Australian Prudential Regulation Authority. 171 In the present case, the Commissioner contended that, because there was no real prospect that EFGA or EFGT would ever pay interest on the loans, the arrangement just described involving the capitalisation and compounding of interest owed to FGL was "highly artificial" and a "device" to protect FGL's ability to pay dividends. 172 In a related way, the Commissioner contended that, to justify the claiming of deductions for interest on borrowings, each of FGL, EFGT, EFGA, Amayana, ELFIC and EFGS had to demonstrate a nexus between those borrowings and the derivation of assessable income. No such nexus could be demonstrated because the presumptive income was "illusory" in the sense that the parties knew that it would never be received by EFGA, EFGT, Amayana and FGL. As ELFIC and EFGS has no prospect of deriving income from the funds on which they were charged interest, the charges only served to create and, presumably, increase losses by those companies. 173 In support of his contentions in this context, the Commissioner pointed to differences of opinion within FGL about whether it should continue to charge interest on loans to subsidiaries. The decision to do so was said to reflect a concern to preserve the ability to pay dividends to FGL shareholders and retain the full advantage of the dividend rebate. Although he accepted that deductibility of interest expenses incurred by a taxpayer has to be assessed in the light of the circumstances obtaining in each tax year, the Commissioner contended that, in this case, there was no relevant change in any year from 1990 to 1998 because the endemic incapacity of the borrower companies prevailed and became worse throughout that time. That consideration reinforced the conclusion that EFGA had incurred its interest expenses to pursue advantages other than the production of income. 174 The Commissioner sought to distinguish the present case from Federal Commissioner of Taxation v R & D Holdings Pty Ltd (2007) 160 FCR 248. In that case, a corporate property developer had borrowed money to finance the construction of flats. The lender/mortgagee went into possession after the borrower defaulted and eventually sold the property after ten years. In the meantime, the mortgagee collected rent from the flats and paid the outgoings. Interest was capitalised from time to time with the result that, by the time of the sale, the borrower owed more than $100 million by way of capital and unpaid interest. The developer's claim of deductions for the interest was upheld at first instance and on appeal in this Court. The point of distinction between R & D Holdings on the present case, according to the Commissioner, is that, in that case, the arrangements between the taxpayer/developer and the mortgagee were at arm's length. The present case is more analogous to Ure v Commissioner of Taxation (1981) 50 FLR 219 where the claim to deduct interest was apportioned having regard to its having been incurred for deductible and non-deductible purposes. In this case, the Commissioner contended, regard should be had to "what the expenditure was calculated to effect from a practical and business point of view"; see Federal Commissioner of Taxation v Firth (2002) 120 FCR 450. Here, the purpose of each expenditure on interest was to benefit FGL and the Foster's Group as a whole; see Hooker Rex Pty Limited v Commissioner of Taxation (1988) 79 ALR 181.

[157]

Consideration of deductibility of interest claimed by ELFIC 176 In my view, the interest incurred by ELFIC on borrowings from EFGA was necessarily incurred in the carrying on by ELFIC of a business for the purpose of gaining or producing assessable income. It was not suggested on behalf of the Commissioner that those interest expenses were a sham. The fact that the interest expenses were significantly greater than the income derived by the taxpayer in each of the years in question does not entail that the expenses were not incurred in carrying on an income producing business. The disproportion is a reflection, rather, of the financial difficulties experienced by ELFIC's external customers in the late 1980's which resulted in diminished returns to ELFIC on the circulating capital deployed in its business. The business being conducted by ELFIC from 1990 onwards was the same business as had been carried on successfully since 1984. The fact that after 1990 ELFIC was in "wind down" mode did not alter the essential nature of that business. This is not a case like that identified in the passage from Fletchers's case quoted at [165] above where the disproportion between the expenditure on interest and the income derived is to be explained by reference to the independent pursuit of some objective other than the carrying on of ELFIC's core business. It does not follow that, because the core business was being wound down, the interest expenditure incurred in continuing the business was not wholly expended in carrying on the business. See, eg, Commissioner of Taxation v Unilever Australia Securities Limited (1995) 56 FCR 152, where Beaumont J observed, at 165; Notwithstanding the respondent's decision not to undertake new financing activities, the "defeasance" arrangements were part of the steps taken in connection with the respondent's business as a finance company. The fact that UAS was winding down its borrowing activities did not mean that the servicing of such borrowings as remained, including making arrangements for the payment to debenture holders, were not part of its ordinary business. It was not an "unusual" transaction in the sense used by Mason J in International Nickel.

[176]

Was the interest expenditure on capital account? 199 An alternative contention of the Commissioner proceeded from the premise that the essential character of the liability was to be determined by objectively identifying the nature of the advantage sought in incurring it. Although it was accepted that interest, as a periodically recurring liability securing the use of money during the term of the loan, is ordinarily a revenue item, the purpose of the interest payment may, in particular circumstances, be something other than raising or maintaining the borrowing. In those circumstances, the purpose of the borrowing might lead to its characterisation as being of a capital nature; see Steele v Deputy Commissioner of Taxation (1999) 197 CLR 459, at 470. In the present case, the interest claimed to be deductible accrued after the Finance Group had ceased to be a going concern and after there was no longer any prospect of repaying the borrowed funds. The advantages gained were the protection of FGL's position as an unsecured creditor of the Finance Group, the preservation of the full rebate on dividends flowing to FGL and the "balancing out" of additional costs incurred by FGL in funding the Finance Group. The debt funding was directed to ensuring the survival of companies in the Finance Group and, so, to establishing and maintaining the capital structure of the Foster's Group as a whole. It was therefore on capital account. 200 As already indicated in relation to EFGS, I do not consider the fact that income-producing activities undertaken in the course of a business may have other purposes or effects militates against the entitlement of a taxpayer conducting those activities to deduct from the assessable income thereby produced an expense of a revenue nature incurred in deriving that income. Even if the corpus of the loan funds deployed by a lender is properly to be regarded as a capital asset in the hands of the lender, the interest paid to secure that capital sum or keep it in circulation is on revenue account. As Bowen CJ and Burchett J said, in Australian National Hotels Ltd v Commissioner of Taxation (1988) 19 FCR 234, at 240; … If the capital is raised by loan, an investment of the borrowed moneys in a business will ordinarily remain an investment of capital, and the same consequences will follow. But there is a special feature of loan capital, which flows from the ephemeral nature of a loan. The cost of securing and retaining the use of the capital sum for the business, that is to say, the interest payable in respect of the loan, will be a revenue item. It creates no enduring advantage, but on the contrary is a periodic outgoing related to the continuance of the use by the business of the borrowed capital during the term of the loan.

[178]

(i) Ashwick 201 A loss of $30,213 claimed to have been incurred by ELFIC in the 1997 income year was transferred to Ashwick all the shares in which were held by FGL either directly or through one or more interposed entities. If allowed, that claimed deduction would have reduced to nil Ashwick's taxable income for the 1997 year. 202 In the 1998 year of income FGL transferred to Ashwick a loss of $23,628 claimed to have been incurred by FGL in that year. That loss was part of a tax loss of $119,899,125 claimed to have been incurred in 1998 which was arrived at after deducting bad debts in respect of interest amounting to $408,058,393 which had been written off by FGL; see [149]-[155] above. If allowed, the claimed deduction of $23,628 would have reduced to nil Ashwick's taxable income for the 1998 tax year. 203 Later, in 2001, Ashwick claimed to deduct from its assessable income for that year a loss of $70 claimed to have been incurred by EFGA in 1998 which was transferred to Ashwick. That loss was part of a tax loss of $1,299,477,144 claimed to have been incurred by EFGA which included EFGA's claims for deductions for bad debts written-off by EFGA in respect of interest and principal owed to EFGA by ELFIC and EFGS; see [83], [85] and [86] above. The same loss also included the deductions claimed by EFGA for interest incurred on loans to EFGA from EFGT and Amayana; see [185] above. 204 That loss by EFGT was part of a tax loss of $525,437,631 which included EFGT's claim for a deduction for writing off as a bad debt the interest owed to EFGT by EFGA; see [145]-[147] above. It also included a claim for interest incurred on loans to EFGT from FBGT; see [198] above. The total claimed deductions of $145 if allowed, would have reduced to nil Ashwick's taxable income for the 1998 tax year. 205 Ashwick's claim for a deduction in the 1997 tax year has to be evaluated in the light of s 79E and s 80G of the 1936 Act. Section 79E, so far as is relevant, provided; (1A) This section does not apply to the 1997/98 year of income or a later year of income. Note 1: To work out the amount of a tax loss for the 1997 98 year of income or a later year of income: see Division 36 of the Income Tax Assessment Act 1997. Note 2: To find out how much of a loss incurred in a post 1989 year of income you can deduct for the 1997 98 year of income or a later year of income: see section 36 105 of the Income Tax (Transitional Provisions) Act 1997. Note 3: For the rules about deducting tax losses from assessable foreign income for the 1997 98 year of income or a later year of income: see section 79DA. (1) For the purposes of this section, a taxpayer incurs a loss in a post 1989 year of income equal to the amount (if any) by which the taxpayer's non loss deductions for the year of income exceed the sum of the taxpayer's assessable income and net exempt income for that year. (2) In spite of subsection (1), if Subdivision B of Division 2A applies in relation to a taxpayer in relation to a post 1989 year of income, then, for the purposes of this section, the taxpayer incurs a loss in the year of income if, and only if, the taxpayer's current year loss amount for the year exceeds the taxpayer's net exempt income for the year, and the amount of the loss is equal to the excess. (2A) In spite of subsection (1), if Schedule 2F applies in relation to a taxpayer for a post 1989 year of income, then, for the purposes of this section, the loss incurred by the taxpayer in the year of income is worked out under section 268 50 of that Schedule. (3) Subject to this section, so much of a taxpayer's losses incurred in any of the post 1989 years of income before a particular year of income as has not been allowed as a deduction from the taxpayer's income of any of those years is allowable as a deduction in accordance with the following provisions: (a) where the taxpayer has not derived exempt income in the particular year of income, the deduction is to be made from the taxpayer's assessable income of that year; (b) where the taxpayer has derived exempt income in that year, the deduction is to be made successively from the taxpayer's net exempt income and from the taxpayer's assessable income of that year; (c) where a deduction is allowable under this section in respect of 2 or more losses, the losses are to be taken into account in the order in which they were incurred. (3A) If a loss referred to in subsection (3) is taken to be reduced under Subdivision 245 E of Schedule 2C in its application to the year of income or a previous year of income, any reference to that loss in this section is to be treated as a reference to that loss as so taken to be reduced. (4) Where a taxpayer has incurred a loss in a post 1989 year of income for the purposes of this section and has also incurred a loss in that year for the purposes of section 79F, only the excess (if any) of the former loss over the latter loss is to be taken into account for the purposes of subsection (3). (5) The losses referred to in subsection (3) are not allowable as a deduction from assessable foreign income of a taxpayer except to the extent provided in an election under subsection (6). (6) A taxpayer who has derived assessable foreign income in a year of income may elect that the whole or a part of the losses referred to in subsection (3) be allowable as a deduction from the taxpayer's assessable foreign income of that year. (7) An election under subsection (6) must be made on or before the date of lodgement of the return of income of the taxpayer for the year of income to which the election relates or within such further period as the Commissioner allows. (8) In spite of any other provision of this section, if, before a year of income, a taxpayer: (a) has become a bankrupt; or (b) not having become a bankrupt, has been released from any debts by the operation of an Act relating to bankruptcy; then no loss incurred by the taxpayer before the day on which the taxpayer became a bankrupt or was so released is an allowable deduction in respect of the year of income under subsection (3). (8A) If: (a) a taxpayer becomes a bankrupt, but the bankruptcy is later annulled; and (b) disregarding the annulment, subsection (8) applies to the bankruptcy; and (c) the annulment occurred under section 74 of the Bankruptcy Act 1966; and (d) under the composition or scheme of arrangement concerned, the taxpayer has been, will be or may be, released from any debts, from which he or she would have been released if he or she had been instead discharged from the bankruptcy; then, for the purposes of subsection (8), the annulment is disregarded. (9) Where: (a) in a year of income (in this section called the payment year), a taxpayer pays an amount in respect of a debt incurred by the taxpayer in a preceding year of income; and (b) that preceding year of income (in this section called the loss year) is a year in which the taxpayer incurred a loss to which subsection (8) applies; then, subject to subsection (10), the amount paid by the taxpayer is an allowable deduction for the payment year, but only to the extent (if any) that it does not exceed so much of the debt as the Commissioner is satisfied was taken into account in calculating the amount of the loss. (10) The total deductions allowable to the taxpayer for the payment year under subsection (9) are not to exceed the amount of the loss reduced by the sum of: (a) the deductions (if any) allowed under subsection (9) from the taxpayer's income of a year or years of income before the payment year in relation to the payment of other amounts in respect of debts incurred by the taxpayer in the loss year; and (b) so much (if any) of the loss as has been allowed under subsection (3) as a deduction or deductions from the taxpayer's income (including the taxpayer's net exempt income) of a year or years of income before the payment year; and (c) so much (if any) of the loss as, but for subsection (8), would have been allowed or allowable under subsection (3) as a deduction or deductions from the taxpayer's net exempt income of the payment year or of a year or years of income before the payment year. (11) Subsections 80(5), (6) and (7) have the same effect in relation to deductions under subsection (3) of this section as they do in relation to deductions under subsection 80(2).

[179]

206 The relevant parts of s 80G are subsections (6) and (6A) which were in these terms; (6) Subject to this section, where: (a) a resident company other than a prescribed dual resident (in this section referred to as the loss company) is deemed to have incurred a loss for the purposes of section 79E or 80 in the year of income that commenced on 1 July 1984 or in a subsequent year of income (in this section referred to as the loss year); (b) a resident company other than a prescribed dual resident (in this section referred to as the income company) has, or would but for the operation of this section have, a taxable income in the year of income that commenced on 1 July 1984 or in a subsequent year of income (in this section referred to as the income year); (ba) the loss company is not a dual resident investment company in relation to the loss year nor in relation to the income year; (c) the loss company and the income company agree that the right to an allowable deduction under subsection 79E(3), 79F(6), 80(2), 80AAA(7) or 80AA(4), as the case requires, in respect of so much of the whole or part of the loss as has not been allowed as a deduction should be transferred to the income company in the income year; (d) in a case where the loss year is the same year of income as the income year: (i) the loss company is a group company in relation to the income company in relation to the loss year; and (ii) if the loss company had incurred the loss in the year of income immediately preceding the loss year and had derived sufficient assessable income (including film income) in the loss year, the loss or that part of the loss, as the case may be, would, but for this section, be allowable as a deduction from the assessable income of the loss company in the loss year (ignoring any exempt income derived by the loss company in the loss year or in that preceding year); and (e) in a case where the income year is a year of income subsequent to the loss year: (i) the loss company is a group company in relation to the income company in relation to the loss year and the income year and in relation to any year of income commencing after the end of the loss year and ending before the commencement of the income year; and (ii) if the loss company had derived sufficient assessable income (including film income) in the income year, the loss or that part of the loss, as the case may be, would, but for this section, be allowable as a deduction from the assessable income of the loss company in the income year (ignoring any exempt income derived by the loss company in the income year); the amount of the loss or of that part of the loss, as the case may be, shall, for the purposes of the application of the provisions of this Act other than this section in relation to the income company in relation to the income year, be deemed to be a loss incurred by the income company for the purposes of section 79E, 79F, 80, 80AAA or 80AA, as the case requires, in: (f) a case to which paragraph (d) applies - the year of income immediately preceding the loss year; or (g) a case to which paragraph (e) applies - the loss year. (6A) An agreement under paragraph (6)(c) must be: (a) in writing and signed by the public officer of each of the loss company and the income company; and (b) made before the date of lodgement of the return of income of the income company for the income year or within such further time as the Commissioner allows.

[180]

The corresponding provisions of the 1997 Act applicable to the losses claimed in the 1998 and 2001 tax years are contained in Division 170 of the 1997 Act. 207 Counsel for Ashwick identified five requirements which have to be fulfilled for a transferred loss to be deductible under s 79E and s 80G of the 1936 Act. They were said to be: (i) the loss company or loss transferor must have a loss for the purposes of the provisions; (ii) the income company or loss transferee must have taxable income in the year in which the loss is to be received; (iii) the loss company and the income company must be members of the same wholly-owned group of companies at all times during the year in which the loss is incurred, the year in which the deduction is claimed and any intervening years; (iv) the loss company and the income company must be Australian resident companies in each of the year of income in which the loss is incurred and the year of income in which the loss is being transferred; and (v) the transfer must be by written agreement between the loss company and the income company which must be signed by the public officer of each company and be made on or before the date of lodgement of the income company's tax return for the year of the deduction. 208 Substantially the same five requirements were said to be imposed by Division 170 of the 1997 Act in respect of deductions claimed in the 1998 and 2001 years of income. 209 It was further submitted on behalf of Ashwick that each of the five requirements identified above had been satisfied in respect of the losses incurred by ELFIC, FGL, EFGA and EFGT and variously transferred to Ashwick in the 1997, 1998 and 2001 years of income. 210 According to Counsel for Ashwick, the Commissioner disputed the deductibility of the tax losses transferred to Ashwick only on the ground that the debts said to have given rise to the losses were affected by the Commercial Debt Forgiveness rules in Division 245 of Schedule 2C of the 1936 Act. It was accepted by Ashwick that the debts owed by EFGA to Amayana were "commercial debts" within the meaning of s 245-25 of Schedule C. 211 However, it was contended on behalf of Ashwick that forgiveness of a commercial debt as contemplated by Schedule C could only occur in one of three ways: (i) by the debt having been released, waived or otherwise extinguished: s 245-35(1); (ii) by the debt having become statute-barred: s 245-35(2); or (iii) by the debt having become subject to an agreement or arrangement whereby the debtor's obligation to pay the whole or a part of the debt is to cease at a particular future time without the debtor incurring any financial or other obligation other than of a nominal or insignificant kind; s 245-35(3). 212 None of those modes of forgiveness, it was said, was applicable to the debts owed by EFGA to Amayana. They remained in existence as evidenced by a deed poll executed by Amayana on 31 July 1998 which recited: A Amayana ("the Creditor") is a creditor of EFG Australia Pty Ltd ("the Debtor") in respect of balances outstanding on advances and accruals of interest less repayments from time to time ("the Debt").

[189]

The existence of a "scheme" 224 The "scheme" identified by the Commissioner in invoking the application of Part IVA of the 1936 Act has been described as comprising "the steps taken by the Foster's Group to fund the Finance Group after November 1989 until 1998 by means of intra-group loans at interest." Those steps have been described inclusively, rather than exhaustively, at [183] of the Commissioner's Appeal Statement. In relation to EFGA, ELFIC and EFGS, the steps were identified as including EFGA's borrowing funds at interest from FGL, Amayana and EFGT, on-lending those funds at interest to ELFIC and EFGS, returning the interest so charged as assessable income and allocating repayments by ELFIC and EFGS to principal and not interest. Another step was identified as the writing-off in 1998 by EFGA as bad debts the moneys due from ELFIC and EFGS under the loans to those companies. A step said to have been taken by ELFIC and EFGS was the claiming by each of those companies as a deduction from its assessable income of the interest charged to it by EFGA. The participation of the Foster's Group as a whole in the scheme postulated by the Commissioner was said to involve the transfer of losses from EFGA, ELFIC and EFGS to Ashwick and EFG Investments. More specifically, FGL was said to have participated in the scheme by lending money at interest to EFGT for the making of loans to EFGA, returning the interest so charged as assessable income, allocating repayments by EFGT to principal, not interest, writing-off in 1998 as bad debts the amounts unpaid under the loans to EFGT and the transfer to other entities in the FGL of losses incurred by FGL. Similarly, EFGT's participation in the scheme was said to consist in its borrowing money at interest from FGL, making loans at interest to EFGA, returning the interest so charged as assessable income, claiming the interest charged by FGL as a deduction, allocating repayments by EFGA to principal, not interest, writing-off in 1998 as a bad debt the moneys due from EFGA under the loans to it and transferring EFGT's losses to other entities in the FGL, including Ashwick. 225 Amayana's participation in the scheme identified by the Commissioner was said to be its borrowing funds at interest from FBGTA, on-lending them at interest to EFGA, returning the interest so charged as assessable income, claiming a deduction for interest charged to it by FBGTA, allocating repayments by EFGA to principal, instead of interest, writing off as bad debts in 1999 the amounts unpaid by EFGA and transferring its (Amayana's) losses to other entities in the FGL including Nexday. Ashwick's, Nexday's and EFG Investments' participation in the scheme was said to be their claiming of deductions in relation to the losses respectively transferred to them. 226 The Commissioner acknowledged that the application of Part IVA "requires more than a possibility. It involves a prediction as to events which would have taken place if the relevant scheme had not been entered into or carried out and the prediction must be sufficiently reliable for it to be regarded as reasonable"; Peabody v Federal Commissioner of Taxation (1994) 181 CLR 359, at 385. 227 I am not persuaded that the steps taken between 1989 and 1998 to provide the members of the Finance Group with loan funds from internal, instead of external, sources amounted to a "scheme" within the meaning of s 177A(1) of the 1936 Act, which provides; "scheme" means: (a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and (b) any scheme, plan, proposal, action, course of action or course of conduct.

[191]

Tax Benefit 229 In case I am wrong in the conclusion just expressed, I proceed to consider whether a tax benefit was obtained by any of the applicants in connection with the scheme postulated by the Commissioner. 230 In the Commissioner's submission, if the scheme which he identified had not been entered into, interest would not have been charged to debtor companies within the Foster's Group after, at the latest, 1 July 1990. In that event, the debtor companies would not have been able to claim the interest as deductions and the creditor companies would not have been able to write off as bad debts moneys due to them as interest. In addition, EFGA derived a further tax benefit from the allocation of repayments made by it first to principal and secondly to interest, thereby increasing the component of the loan account balance attributable to interest. 231 The Commissioner further contended that, if FGL had not entered into the scheme, interest after 1990 would not have been charged within the Finance Group but the loans to those companies would have been treated as interest-free. Secondly, by allocating repayments on a first-in, first-out basis in accordance with the rule in Clayton's case, instead of applying them first to the liability for interest, FGL increased the amount of interest which was ultimately written off as bad debts in 1998. The resultant tax losses were transferred to the benefit of "income companies" in the Foster's Group. 232 A "tax benefit" is defined relevantly in s 177C(1) of the 1936 Act, in these terms: (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: (a) an amount not being included in the assessable income of the taxpayer of a year of income where that amount would have been included, or might reasonably be expected to have been included, in the assessable income of the taxpayer of that year of income if the scheme had not been entered into or carried out; or (b) a deduction being allowable to the taxpayer in relation to a year of income where the whole or a part of that deduction would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer in relation to that year of income if the scheme had not been entered into or carried out;

[193]

234 The tax benefits relied on by the Commissioner as flowing to various applicants were the deductions claimed for bad debts written-off, the deductions for interest expenses claimed to have been incurred and the deductions respectively claimed by Ashwick, Nexday and EFG Investments for transferred tax losses. 235 Making the prediction on the hypothesis enjoined by the High Court in Federal Commissioner of Taxation v Peabody (1993)181 CLR 359, I am not persuaded that, if the scheme postulated by the Commissioner had not been entered into, the deductions referred to in the last preceding paragraph would not have been allowable or might reasonably be expected not to have been allowable. I have already indicated, at [228] above, a basis on which interest could reasonably have been charged to borrowers in the Foster's Group even in the absence of the presumptive scheme. On that basis, the facility of lenders within the Group to write off as bad debts amounts of unpaid interest would still have existed and have provided the foundation for deductions being allowed to those lenders in the year or years in which the write-offs occurred. 236 There is also considerable force in the contention advanced on behalf of the applicants that, on the hypothesis required by s 177C(1) that the presumptive scheme had not been entered into, the interest income on which the deductibility of the bad debts written-off and the interest incurred on intra-group loans was predicated would not have been derived. On that hypothesis, the tax benefit imputed to the scheme propounded by the Commissioner would not have been achieved. 237 I also agree with the contention advanced on behalf of the applicants that the deductions claimed to have been available as a result of the transfers of tax losses to Ashwick, Nexday and EFG Investments, occurred as a result of the making of agreements expressly provided for by the Act. For the reasons already explained, I am satisfied that the presumptive scheme was not entered into for the purpose of enabling those agreements to be made. The agreements for the transfer of tax losses therefore fall within the exception created by s 177C(2)(b) of the 1936 Act which provides; (2) A reference in this Part to the obtaining by a taxpayer of a tax benefit in connection with a scheme shall be read as not including a reference to: … … … (b) a deduction being allowable to the taxpayer in relation to a year of income the whole or a part of which would not have been, or might reasonably be expected not to have been, allowable to the taxpayer in relation to that year of income if the scheme had not been entered into or carried out where: (i) the allowance of the deduction to the taxpayer is attributable to the making of a declaration, agreement, election, selection or choice, the giving of a notice or the exercise of an option by any person, being a declaration, agreement, election, selection, choice, notice or option expressly provided for by this Act or the Income Tax Assessment Act 1997, except one under Subdivision 960 D of the Income Tax Assessment Act 1997; and (ii) the scheme was not entered into or carried out by any person for the purpose of creating any circumstance or state of affairs the existence of which is necessary to enable the declaration, agreement, election, selection, choice, notice or option to be made, given or exercised, as the case may be;

[198]

(i) Manner in which the scheme was entered into or carried out - s 177D(b)(i) 242 Under this heading, the Commissioner instanced the refinancing of EFGA and, through it, the Finance Group, by loans made at interest and later, from 1992, by the making of loans from FGL at interest to EFGT which were then on-lent, also at interest, to EFGA which used the funds to repay the principal and interest on outstanding loans made to it by AML Finance and FGL. As well, EFGT, from the year ended 30 June 1992, made additional new loans at interest to EFGA using funds borrowed from FGL, also at interest. The actions of FGL in entering into that chain of transactions were said to be informed by FGL's knowledge that EFGA, ELFIC and EFGS lacked the ability to pay interest on their respective borrowings which, in turn, affected Amayana's ability to pay interest on its borrowings from FBGTA. Similarly, EFGA had no capacity to make regular and timely payments of interest on its borrowings from EFGT and Amayana. 243 The capitalisation and compounding from month to month of interest allowed it greatly to exceed the assets of the Finance Group, EFGT and Amayana. It was further said by the Commissioner that, as a result of EFGA having, in October 1991, given security over its assets to EFGT but having given no security to Amayana, Amayana's loan to EFGA became irrecoverable but was not written-off until July 1998. As well, the Commissioner claimed, the inclusion of EFGT and Amayana in the funding structure, "multiplied the bad debt deductions." 244 Members of the Finance Group, EFGT and Amayana were, in real terms, insolvent from November 1989 and were only enabled to continue to trade as a result of resolutions, letters of comfort and guarantees to external creditors given by FGL. The Commissioner also pointed to the change after 30 June 1994 in the allocation of repayments by internal creditors which were applied on a FIFO basis, first to repayment of older outstanding advances of capital. 245 Another feature of the treatment of debts internal to the Foster's Group to which the Commissioner pointed was the fact that companies within the Group which received transferred losses did not make subvention payments to the transferor companies. Such payments would have reduced the bad debts due from the loss companies and consequently have minimised the "losses" incurred by the creditor companies when they wrote-off as bad the debts owed by the debtor companies. 246 The matters identified by the Commissioner were said to go to the manner in which the scheme was entered into or carried out and to accentuate the predominance of a purpose of obtaining the tax benefits. The creditor companies did not gain the usual advantage of charging interest, namely a return on their loans. The economic advantage accrued solely in the form of tax benefits to the FGL as a whole. 247 I doubt whether any of the matters instanced by the Commissioner under this head goes to the "manner" in which the scheme to which he pointed was entered into or carried out. It has to be borne in mind that the question of dominant purpose will usually be determined at the time when the alleged scheme was entered into; see Vincent v Commissioner of Taxation (2002) 124 FCR 350, at 372. In the present case some of the matters relied on by the Commissioner such as the charging of interest to subsidiaries within the Finance Group predated the time ascribed by the Commissioner to entry into the scheme. 248 In any event, the features identified by the Commissioner as going to "manner" were explicable as actuated by a dominant purpose other than the obtaining of a tax benefit. The fact that intra-group loans to Finance Group subsidiaries were made at interest is at least as readily explicable by a concern to measure or monitor the performance of the borrowing companies. A similar observation can be made about the compounding or capitalising of the interest after timely payments had ceased to be made with any regularity. A corresponding explanation is available in respect of some loans based on the security structure which, as described at[41] above, had been erected in mid-1991 to provide a measure of protection for the Foster's Group assets from external creditors. 249 The delay in writing off bad debts owed by borrowers to lenders within the Foster's Group was, I consider, at least equally explicable by a belief held by the relevant finance officers before 1997 that the debts were not wholly irrecoverable. Support for that belief was available from the fact that repayments were made from time to time after 1992 by even the most heavily indebted subsidiaries as assets were realised. 250 I do not regard the allocation after 1994 of repayments by the borrowing subsidiaries on a "first in first out basis" as part of the manner of carrying out the alleged scheme which indicates the proscribed dominant purpose. Where separately identifiable debts or components of a debt were owed by a particular subsidiary, it was obviously necessary to make an election as to which debt or component was to be reduced or eliminated by a given part payment. The allocation of some of such part payments to reduction or elimination of the oldest advances of principal was logically justifiable otherwise than by reference to a tax benefit in the form of an ability at some time in the future to transfer within the Foster's Group tax losses which could not have been quantified at the time of each part payment. Similar considerations apply to the absence of subvention payments to the transferor loss companies which were parties to the tax loss agreements. The absence of such payments is explicable by the fact that the agreements were entirely "in house" so that any subvention would have had a purely neutral effect on the consolidated finances of the Foster's Group. The relatively small amounts of some of the tax losses involved also militates against the existence of a dominant purpose to obtain a tax benefit in the form of deductions for transferred losses claimable by the transferee companies.

[200]

(iii) Time of entry into alleged scheme and period during which it was carried out - s 177D(b)(iii) 253 The Commissioner pointed to the fact that, by 1990, it was apparent that ELFIC and EFGS could not repay principal and interest under existing loans which inability had a repercussive effect on EFGA as the internal treasury. Despite EFGA's making dramatically increasing provision between 1991 and 1997 for doubtful debts from intra-group borrowers, it did not write-off the debts as bad until June 1998, preferring, instead, to charge and capitalise interest on the outstanding loans. 254 The Commissioner also focused specifically on 19 June 1998 as the date on which EFGA, EFGT and FGL wrote off as bad debts the loan amounts respectively due to each of those companies. It was said that, by making the write-off take effect at 30 June 1998, "the creditor companies maximised the deductions that would be available, since interest continued to accrue up to 30 June 1998, even after the boards had resolved to write-off the loans." On the other hand, it was pointed out that Amayana's write-off in July 1998 had been "reasonably contemporaneous" with the actions of EFGA, EFGT and FGL but allowed Amayana to schedule the tax effect of the write-off for the year of income ended 30 June 1999. 255 In the light of the timing of the events outlined above and the period over which interest had been allowed to accrue, the Commissioner argued that it could readily be inferred that the scheme had been entered into primarily to obtain tax benefits. 256 Usually, in this context, the time of entry into a scheme is said to be significant because it coincides with, or is closely proximate to, the end of a tax year in which the presumptive tax benefit is sought to be obtained. In the present case, the scheme alleged by the Commissioner was said to have entered into after November 1989 so that 19 June 1998 cannot assume the significance which the Commissioner has attached to it. I can discern nothing in the events which occurred at about that time which tends to indicate that a purpose of the relevant actors was to obtain a tax benefit. Those events were a natural consequence, in the light of changed financial circumstances, of pre-existing arrangements between the members of the Foster's Group as a whole and of the arrangements to which particular members of the Finance Group were parties. 257 Similarly, the period over which the alleged scheme was carried out does not assist in imputing the requisite purpose to any relevant person. It is clear from the evidence that the period over which various arrangements were maintained between lenders and borrowers within the Foster's Group was dictated by the time needed to realise assets and make repayments of principal and interest. There is nothing to suggest that any presumptive tax benefit was predicated on an event occurring within, or after the lapse of, a particular period of time.

[202]

(v) Any change in the financial position of the relevant taxpayer that has resulted, or will result, or may reasonably be expected to result from the scheme - s 177D(b)(v) 260 The circumstances detailed under this head by the Commissioner essentially replicated aspects of the alleged scheme which have already been discussed. In particular, it was contended that, although the unpaid interest had been returned as income by creditor companies, the off-setting of those amounts by claims for deductions of interest on borrowed funds and the writing-off of bad debts "in effect resulted in a duplication of claims for tax deductions within the corporate group for the 1997-1998 period." 261 It was said that the failure to charge interest on intra-company loans meant that there was no net impact, apart from a beneficial tax impact, on the accounting positions of creditor companies within the Foster's Group. As well, the charging of interest on intra-group loans "washed out on consolidation" and was therefore of no concern to FGL. Correspondingly, the accrued interest expense had no effect on the ability of companies in the Foster's Group to discharge their obligations to external creditors or on the cash position of the Finance Group companies. The effect would have been the same had the scheme not been entered into. 262 The capitalisation and compounding of unpaid interest meant that it exceeded the interest on external borrowings to fund the Finance Group and "augmented the beneficial tax effects" of the tax deductibility of interest expenses and the dividend cash flow to FGL shareholders. 263 There were clearly changes in the respective financial positions of various members of the Foster's Group from time to time between 1989 and 2000. Many of those changes resulted from external forces which were regarded, for reasons unrelated to any tax benefit, as compelling internal adjustments of assets and liabilities and a re-arrangement of security over some assets. Some of those adjustments, although they involved a substitution of internal lenders for outside financiers, did not significantly change the financial position of the relevant borrower. Corresponding changes also resulted in some lending companies within the Foster's Group deriving assessable income in the form of interest on loans which had not been derived before the changes occurred. On balance, I do not regard these changes, or those more specifically indicated by the Commissioner, as strengthening or weakening the inference that the alleged scheme was entered into or carried out for the dominant purpose of obtaining a tax benefit.

Parties

Applicant/Plaintiff:

Ashwick (Qld) No 127 Pty Ltd (ACN 010 577 456)

Respondent/Defendant:

Commissioner of Taxation

Legislation Cited (3)

IXL Ltd) FGL Harlin Holdings Pty Limited Harlin Income Tax Assessment Act 1936(Cth)

Income Tax Assessment Act 1936(Cth)

Income Tax Assessment Act 1997(Cth)

Cases Cited (34)

Ashwick (Qld) No 127 Pty Ltd (ACN 010 577 456) v Commissioner of Taxation [2009] FCA 1388 TAXATION - deductible expenses - written-off bad debts - whether deductible under s 25-35, Income Tax Assessment Act 1936 (Cth) or s 8-1, Income Tax Assessment Act 1997 (Cth) - whether debts incurred in the "ordinary course of… business" - intra-group debt arrangements.

Australian National Hotels Ltd v Federal Commissioner of Taxation (1988) 19 FCR 234 BHP Billiton Petroleum (Bass Strait) Pty Ltd v Commissioner of Taxation (2002) 126 FCR 119 Coal Developments (German Creek) Pty Ltd v Federal Commissioner of Taxation (2008) 166 FCR 140 Commissioner of Taxation v Bivona Pty Ltd (1990) 21 FCR 562 Commissioner of Taxation (SA) v The Executor Trustee and Agency Company of SA Limited (1938) 63 CLR 108 Commissioner of Taxation v Unilever Australia Securities Limited (1995) 56 FCR 152 Cross (Inspector of Taxes) v London & Provincial Trust Ltd [1938] 1 KB 792 Edgelow v MacElwee [1918] 1 KB 205 Fairway Estates Pty Ltd v Federal Commissioner of Taxation (1970) 123 CLR 153 Federal Commissioner of Taxation v Consolidated Press Holdings Ltd (2001) 207 CLR 235 Federal Commissioner of Taxation v Firth (2003) 120 FCR 450 Federal Commissioner of Taxation v Hart (2004) 217 CLR 216 Federal Commissioner of Taxation v R & D Holdings Pty Ltd (2007) 160 FCR 248 Federal Commissioner of Taxation v Total Holdings (Aust) Pty Ltd (1979) 24 ALR 401 Fletcher v Federal Commissioner of Taxation (1991) 173 CLR 1 Franklin's Selfserve Pty Ltd v Federal Commissioner of Taxation (1970) 125 CLR 52 Henderson v Federal Commissioner of Taxation (1969) 119 CLR 612 Hooker Rex Pty Limited v Commissioner of Taxation (1988) 79 ALR 181 Hungier v Grace (1972) 127 CLR 210 J Rowe & Son Pty Ltd v Federal Commissioner of Taxation (1970-71) 124 CLR 421 Kidston Goldmines Ltd v Commissioner of Taxation (1991) 30 FCR 77 Macquarie Finance Ltd v Commissioner of Taxation (2005) 146 FCR 77 North Australia Pastoral Co Ltd v Federal Commissioner of Taxation (1944) 71 CLR 623 Northern Engineering Pty Ltd v Federal Commissioner of Taxation (1979) 42 FLR 301 Odhams Press v Cook [1940] 3 All ER 15 Peabody v Federal Commissioner of Taxation (1994) 181 CLR 359 Permanent Trustee Co (Executors of F H Prior dec) v Federal Commissioner of Taxation (1940) 6 ATD 5 Richard Walter Pty Ltd v Commissioner of Taxation (1995)95 ATC 4440 Spassked Pty Ltd v Federal Commissioner of Taxation (No 5) (2003) 197 ALR 553 Spassked Pty Ltd v Federal Commissioner of Taxation (2003) 136 FCR 441 Stage Club Ltd v Millers Hotel Pty Ltd (1981) 150 CLR 535 Steele v Deputy Commissioner of Taxation (1999) 197 CLR 459 St Lucia Usines & Estates Co Ltd v Colonial Treasurer of St Lucia [1924] AC 508 Ure v Commissioner of Taxation (1981) 50 FLR 219

(1988) 19 FCR 234

(2002) 126 FCR 119

(2008) 166 FCR 140

(1990) 21 FCR 562

(1938) 63 CLR 108

(1995) 56 FCR 152

(1970) 123 CLR 153

(2001) 207 CLR 235

(2003) 120 FCR 450

(2004) 217 CLR 216

(2007) 160 FCR 248

(1979) 24 ALR 401

(1991) 173 CLR 1

(1970) 125 CLR 52

(1969) 119 CLR 612

(1988) 79 ALR 181

(1972) 127 CLR 210

(1991) 30 FCR 77

(2005) 146 FCR 77

(1944) 71 CLR 623

(1979) 42 FLR 301

(1994) 181 CLR 359

(2003) 197 ALR 553

(2003) 136 FCR 441

(1981) 150 CLR 535

(1999) 197 CLR 459

(1981) 50 FLR 219

(1969) 118 CLR 529

(1971) 126 CLR 177

(1970) 119 CLR 453

(2002) 120 FCR 450

(2002) 124 FCR 350

Cited By (1)

Commissioner of Taxation v Ashwick

At a glance

Court

Decision date

Source

Judgment (222 paragraphs)

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Legislation Cited (3)

Cases Cited (34)

Cited By (1)