This subsection has effect subject to subsection (2) (requirement for financing arrangement).
59 In its concluding words, s 974-75(1) is expressed to have effect subject to s 974-75(2), which provides:
A *scheme that would otherwise give rise to an *equity interest in a company because of an item in the table in subsection (1) (other than item 1) does not give rise to an equity interest in the company unless the scheme is a *financing arrangement for the company.
60 In his particulars (see [52(2)] above), the Commissioner identified the relevant scheme as:
[T]he Profit Participation Agreement which was entered into on 5 May 1994, amended in 1996, replaced on 15 October 1999, and replaced in June 2003 (the PPA), together with the Shareholders Agreement entered into on 5 May 1994 (the SA), and the steps taken to implement them.
61 For the purposes of this case, having regard to the terms of s 974-110(1) of the 1997 Act, the applicant submitted that the relevant scheme is strictly that which existed just before 15 March 2007 when the applicant executed the Declaration, which will involve the IPPA 2005, not the IPPA 2003, and the SA 2005, not the SA 1994. I agree with that submission, but that aside, the applicant submitted that there were two substantive reasons why the scheme identified by the Commissioner did not satisfy the equity test.
62 The first reason advanced by the applicant was that the scheme identified by the Commissioner aggregates two separate schemes in an impermissible manner. The thrust of this submission was that accepting that the two separate constituent schemes were related schemes as defined in s 974-155, the conditions for them to be aggregated, as a notional scheme, set out in paras (a), (b) and (c) of s 974-70(2), were not satisfied; s 974-70(3) was satisfied in respect of each of the constituent schemes so as to render s 974-70(2) inapplicable; the related scheme provisions of ss 974-70(2) to (5) were intended to be exhaustive or "to cover the field", so to speak, as to when aggregation was permissible; and outside those provisions, aggregation was not permissible.
63 This short summary might not do justice to the submission; it is a submission which is undoubtedly arguable, but that said, I think it is easier and, if only for that reason, preferable to decide whether the aggregate scheme as identified by the Commissioner satisfies the equity test, by reference to the second of the substantive reasons advanced by the applicant as to why it does not; it is to that matter that I now turn.
64 The second reason the applicant advanced was that, even if the aggregate scheme identified by the Commissioner is permissible, it fails the equity test in any event because it does not satisfy the requirement in s 974-75(2) that the scheme is a "financing arrangement" for GI.
65 Despite the particulars provided by the Commissioner (see [52(1)] above), it was common ground that the applicant was not a "member or stockholder" of GI such as to attract Item 1 of the table in s 974-75(1). As noted in [58] above, by virtue of s 974-75(2), the other items of the table in s 974-75(2) do not give rise to an equity interest in GI unless the scheme is a "financing arrangement" for GI.
66 The definition of "financing arrangement" is in s 974-130(1):
A *scheme is a financing arrangement for an entity if it is entered into or undertaken:
(a) to raise finance for the entity (or a *connected entity of the entity); or
(b) to fund another scheme, or a part of another scheme, that is a *financing arrangement under paragraph (a); or
(c) to fund a return, or part of a return, payable under or provided by or under another scheme, or a part of another scheme, that is a financing arrangement under paragraph (a).
67 It was common ground that GH was a connected entity of GI at all relevant times.
68 In his particulars (see [52(3)] above), the Commissioner identified two ways in which he contended that the aggregate scheme was a financing arrangement for GI:
(1) The scheme was undertaken to raise finance for GH, a connected entity of GI, as the applicant purchased shares in GH.
(2) The scheme was undertaken to raise finance for GI, by a contribution of capital to GI by way of services in respect of which a return is paid by GI.
69 In relation to the first way, the Commissioner put his case as follows: The definition of "financing arrangement" does not, in terms or by implication, import a requirement that finance must be raised to meet a capital "need" on the part of any particular entity. Such a quantitative assessment is not provided for in s 974-130(1). Rather, the section speaks in terms of a "scheme … entered into or undertaken … to raise finance". Within this textual formulation, there is no need to consider the amount of capital to be raised. The question under s 974 is qualitative, not quantitative. Here, the scheme was a "financing arrangement" for the purpose of s 974-130(1) because it required a contribution of share capital to GH (a connected entity of GI within the meaning of s 974-130(1)(a)). That contribution was a form of "finance" for GH. Whether GH had a need for that finance in the sense that it was required for its operations, or could not otherwise have been raised, is beside the point.
70 It may be accepted that, irrespective of whether capital raised was needed or required as finance, a scheme entered into or undertaken to raise capital could be a "financing arrangement'. The need or requirement for finance is not determinative although the existence of such a need or requirement might more readily lead to the conclusion that the scheme was entered into or undertaken to raise finance. But such a conclusion might well be reached where there is no such need or requirement but where the relevant facts and circumstances lead to the conclusion that finance is being raised on a stand-by basis or as a reserve fund.
71 Equally, the amount of capital raised by the issue of shares will not, of itself, be determinative of whether the arrangement is entered into or undertaken to raise finance for the company issuing the shares. But para (a) of the definition of "financing arrangement" requires the scheme to be entered into or undertaken "to raise finance for the entity", not just capital. The two are not coterminous, and a conclusion that a scheme is entered into or undertaken to raise capital for prudential, management or other good governance reasons will not be entered into or undertaken to raise finance which contemplates, sooner or later, expenditure of the amount raised. Unless that dichotomy is observed, each and every raising of capital, irrespective of the objective purpose of the raising, will be a raising of finance. In my view, such a conclusion is not consistent with the legislative intention to be discerned from the text of s 974-130(1), viewed in the context of Div 974 of the 1997 Act as a whole.
72 More specifically, whether or not a scheme is a "financing arrangement" will depend upon the conclusion one would draw, from all the relevant facts and circumstances, as to the purpose or object of the scheme. Contrary to the submission of the Commissioner in [68] above, the fact that capital is paid, or contributed in kind, to a company does not, without more, lead to the conclusion that the scheme was a "financing arrangement". More is required before one can draw any such conclusion. What this exemplifies is that no relevant fact or circumstance is determinative although the weight each carries in the determination process may well be different.
73 The identity of the relevant facts and circumstances in the determination process will vary from case to case but there will be some common indicia to consider. These include the objectively discerned intention of the parties; the size and nature of the company's business; the size and nature of its other debt obligations; the size and nature of the capital raised under the scheme; the existence and extent of any non-financing purposes of the scheme; and the identity and nature of the provider or providers of the capital so raised - which has at one end of the spectrum a bank or finance company, and at the other end employees of the company or an affiliate participating in a scheme of remuneration. All these will be relevant, albeit non-determinative, facts and circumstances in the determination process.
74 In the present case, apart from the fact that capital was raised by GH each and every time it issued shares to participants in the PPPs, there were no indicia which pointed to the scheme, as identified by the Commissioner, being a financing arrangement. Indeed, all relevant indicia point to the contrary. One has only to review SA 2005 to realise that the Commissioner's submission has no substance. None of the recitals suggest that the purpose of SA 2005 is to raise finance for GH. Indeed, the recitals suggest that the main purpose of GH's existence is to act as a holding company, to hold the shares of GI, and that the shareholders of GH (which include the applicant) wish to provide for the stability of GH and its majority holding in GI; to promote the continuity of the management and policies in both GI and GH; and to restrict the manner and means by which the shares in GH may be sold, assigned or otherwise transferred.
75 All of this points to the raising of capital by the issue of shares by GH to participants in the PPPs being for the ongoing internal management of both GH and GI being maintained in the hands of those participants; this is exemplified in the following clauses in the operative part of SA 2005:
C.1.3.2 The purpose of GH is the purchase from GI of up to 100% of the voting stock of GI and to hold such participation and to exercise its controlling interest in GI as a majority shareholder and through its nominees on the board of GI.
The purpose of GH is neither the generation of profits nor the distribution of dividends to Shareholders.
…
C.2.3.1. In its capacity as major shareholder of GI and through its nominees on the board of GI, GH will provide that, to the extent permitted by law, profits of GI are in principle not distributed as dividends to shareholders of GI, with the exception of a preferred dividend to GH on its registered shares B in GI as provided for in GI's articles and necessary for covering GH's expenses, in particular interest payments due on the loans extended by GI to GH, and GH will provide that profits are otherwise distributed according to GI's contractual obligations, in particular under Profit Participation Agreements or Incentive Profit Participation Agreements or Profit Participation Option Agreements or other similar agreements concluded with Shareholders.
…
D.4.1.3. Unless GH's last audited stand-alone financial statements state reserves and/or retained earnings, the purchase price for the Shares shall be equal to their par value.
Should at the time the Exercise Event occurred, GH's last audited stand-alone financial statements state reserves and/or retained earnings, the purchase price shall be equal to the affected Shareholder's proportionate share of shareholders' equity, as presented in GH's audited stand-alone financial statements, calculated on the number of Shares to be purchased. If the option is exercised between January 1 and June 30, the purchase price shall be calculated based on GH's stand-alone financial statements as of December 31 of the preceding year, if the option is exercised between July 1 and December 31, the purchase price shall be calculated based on GH's stand-alone financial statements of the same year.
76 For all these reasons, I do not accept the first way the Commissioner put his case as to why the aggregate scheme he identified was entered into or undertaken to raise finance for GH and, because it was a connected entity of GI, that aggregate scheme was a "financing arrangement" of GI within s 974-130(1).
77 The second way the Commissioner put his case on this issue was that the aggregate scheme was undertaken to raise finance for GI itself by a contribution of capital to GI by way of services in respect of which a return is paid by GI.
78 I have to admit of some difficulty in understanding this second way and, for that reason, have reproduced below the Commissioner's written submissions verbatim.
79 The Commissioner submitted that the "financing arrangement" was of the kind described in the Explanatory Memorandum to the New Business Tax System (Debt and Equity) Bill 2001 (Cth):
2 .7 The raising of finance generally entails a contribution to the capital of an entity, whether by way of money, property or services, in respect of which a return is paid by the entity, be it contingent (connoting equity) or non-contingent (connoting debt). It is important, however, to consider all the relevant circumstances and features of a particular arrangement to determine whether, in substance, it is appropriately characterised as a financing arrangement or not. In this regard, the intentions of the parties to the arrangement may be relevant, but are not determinative.
2.8 In the vast majority of cases it is readily apparent whether a particular arrangement constitutes the raising of finance. The issuing of a debt/equity hybrid instrument, whether in consideration for money (as would usually be the case), property or the provision of services, would, for example, constitute a financing arrangement. Conversely, a financing arrangement is not created from a contract for personal services entered into in the ordinary course of business where, in consideration for the provision of services, the employer provides a return in the form of salary commensurate with the value of the services provided. This is the case even if there is some delay between the provision of services and the payment of the salary, as occurs when, for example, an employer provided long service leave payments in recognition of services provided several years before ...
2.9 However, the example of an employment contract demonstrates how important it is to consider all the relevant circumstances and features of a particular arrangement to determine whether, in substance, it is appropriately characterised as a financing arrangement or not. This is because in certain, albeit unusual, circumstances an employment contract may constitute a financing arrangement, as Example 2.4 shows. The example illustrates an exception to the general rule that employment contracts do not constitute financing arrangements.
80 Example 2.4 set out in the Explanatory Memorandum reads:
A company issues shares to all the members of a family except one, who is instead employed by the company for a salary contingent on profits of the company. The calculation of the salary is such that the employee receives a return equivalent to that of the other family members on their shares (increased to reflect the value of the services provided).
In these unusual circumstances the employment contract would constitute a financing arrangement because the employee is effectively funding the company by providing services instead of money. The employment contract is a substitute for shares in the company.
81 The Commissioner then submitted:
As the passages extracted from the Explanatory Memorandum above make clear, the contribution of services can constitute raising finance, and contracts for services may, in some cases, amount to financing arrangements within the meaning of s 974-130(1).
82 There is a threshold difficulty in the way of acceptance of this submission in that the applicant's service agreement with Glencore Australia dated 2 January 2002 was not identified as being a constituent scheme or part of the aggregate scheme particularised and relied on by the Commissioner (see [52(2)] above). That difficulty aside, there are other obstacles in the way of its acceptance spelt out below.
83 The essence of the Commissioner's submission is perhaps best summed up in the following extract from his written submissions:
The effect of the arrangement was that GI was entitled to retain profits (instead of distributing them) indefinitely and would not be required to distribute them for so long as - and to the extent that - its owners remained employed in the business. The arrangement was thus also one whereby GI raised finance, in the form of an ability to retain profits, in return for the service of its key personnel.
84 In relation to the aggregate scheme particularised by the Commissioner, the IPPA on its face did not raise, nor could have been intended to raise, any finance for GI (or GH): the applicant's rights under the IPPA 2005 (and all previous IPPA and PPPs) were acquired for nil consideration. Furthermore, the preamble to the IPPA 2005 describes the Incentive Profit Participation Plan as one of deferred compensation for selected employees of GI and its subsidiaries for services provided by employees. Objectively, the agreements are not consistent with the Commissioner's contention.
85 The example in the Explanatory Memorandum is clearly distinguishable from the present case. Each employee receives a salary (in no way contingent on the profits of GI or any affiliate employer company) and discretionary bonuses in addition to their rights under the PPPs so employees cannot be said to be "effectively funding the company by providing services instead of money". Rather they are being rewarded for their performance by deferred compensation.
86 In any event, an example in an explanatory memorandum cannot control the meaning of the text of the statute: see, e.g., Brooks v Commissioner of Taxation (2000) 100 FCR 117 at 135-136. The Commissioner's contention rests on the idea that an employee's provision of services constitutes the provision of "finance" to the employer. Whether that is right, and s 974-130(3)(b) of the 1997 Act casts serious doubt on that notion, the relevant statutory question is whether the scheme was entered into or undertaken "to raise finance". The word "raise" at least suggests that but for the scheme the company would not have the finance which the scheme is intended to provide, and further, that as a result of the scheme the company has an increased ability to finance activities of the company that it would not otherwise be able to finance. But under the IPPA 2005, GI acquired no more services from the employee than it was already entitled to, and had no greater ability to finance its activities.
87 For all these reasons, I do not accept the second way the Commissioner contended that the aggregate scheme was a financing arrangement for GI.
88 I am therefore of the view that the aggregate scheme particularised and relied on by the Commissioner does not satisfy the equity test in s 974-75(1) and it follows, in my view, that that scheme does not give rise to an equity interest in GI under s 974-70(1) because para (a) is not satisfied. As noted in [56] above, both limbs, paras (a) and (b), must be satisfied for a scheme to give rise to an equity interest in a company.
89 The applicant also submitted that even if, contrary to the conclusion in [87] above, the aggregate scheme particularised and relied on by the Commissioner does satisfy the equity test in s 974-75(1) so that the para (a) limb of s 974-70(1) is satisfied, that scheme will not give rise to an equity interest in GI because, under the para (b) "tie-breaker" limb of s 974-70(1), the interest can be characterised as part of a larger interest that is characterised as a debt interest in GI, or a connected entity of GI, under Subdiv 974-B. It is not necessary that I consider this submission having regard to my conclusion that the equity test in s 974-75(1) is not satisfied and the para (a) limb of s 974-70(1) is therefore not satisfied. However, I should say that I do not accept the submission: I am not satisfied that the "effectively non-contingent obligation" requirement in para (c) of the debt test in s 974-20(1) is satisfied having regard to the terms of s 974-135(3) as to when an obligation is non-contingent.
90 But it does follow from my conclusion in [87] above that the GS issued to the applicant by GI were not equity interests, and therefore not non-share equity interests, in GI, that the amounts paid to the applicant by GI could not be dividends or non-share dividends. It is therefore strictly unnecessary to consider the assessability of such amounts and, if assessable, the year or years of derivation; however, I will make the following summary comments and conclusions on the premise that such amounts were dividends or non-share dividends.
91 If they were dividends, they would only be dividends by operation of s 159GZZZP(1) of the 1936 Act - where there is a buy-back of a share or a non-share equity interest by a company in an off-market purchase - which provides that an arithmetical difference "is taken to be a dividend paid by the company -
(c) to the seller as a shareholder in the company; and
(d) out of profits derived by the company; and
(e) on the day the buy-back occurs."
While such a dividend would be assessable to the applicant by virtue of s 44(1)(a)(i) of the 1936 Act, it would be wholly assessable in the 2007 income year (s 159GZZZP(1)(e)). So much was conceded by the Commissioner.
92 If the amounts paid to the applicant by GI were non-share dividends by virtue of ss 974-115 and 974-120 of the 1997 Act, they would not be assessable under s 44(1)(a)(ii) of the 1936 Act because the applicant was not a "shareholder" in GI and there is no relevant deeming as there is in s 159GZZZP(1)(c). That difficulty aside, any assessability under s 44(1) would arise in the 2007 income year when the non-share dividend was "paid" by GI. There could be no argument that in that year the non-share dividend was, at the request and with the agreement of the applicant, credited to him in full: see the definition of "paid" in relation to dividends or non-share dividends in s 6(1) of the 1936 Act; see too Brookton Co-operative Society Limited v Federal Commissioner of Taxation (1980-1981) 147 CLR 441 at 455-456 per Mason J.