British American Tobacco Australia Services Limited v Commissioner of Taxation

INTRODUCTION 1 This proceeding concerns a determination made by the respondent, the Commissioner of Taxation (the Commissioner), under Part IVA of the Income Tax Assessment Act 1936 (Cth) (the 1936 Act), that an amount should be included in the assessable income of the applicant, British American Tobacco Australia Services Limited (formerly known as WD & HO Wills (Australia) Limited) (the Taxpayer). The Commissioner made the determination because he concluded that the Taxpayer had obtained a tax benefit in connection with a scheme within the meaning of Part IVA of the 1936 Act. The proceeding also raises the question of whether the Commissioner erred in the application of s 226E of the 1936 Act, which provides for the reduction of penalty tax in certain circumstances. 2 The questions in the proceeding arise out of the global merger of the British American Tobacco group of companies (the BAT Group) and the Rothmans International group of companies (the Rothmans Group), which was completed in September 1999. The BAT Group consisted of British American Tobacco plc (BAT UK) and its subsidiaries. BAT UK was a listed public company in the United Kingdom. The Rothmans group consisted of Rothmans International BV (Rothmans International) and its subsidiaries. Rothmans International was owned as to 67% by Compagnie Financiere Richemont AG, a public company in Switzerland (Richemont) and as to 33% by Rembrandt Group Limited, a public company in South Africa (Rembrandt). The BAT Group and the Rothmans Group both had operations throughout the world, including Australia. 3 On 28 September 2000, the Taxpayer lodged its company tax return for the Taxpayer's year of income ended 30 June 2000 (the 2000 income year). The return showed taxable income of $22,712,870. Pursuant to s 166A of the 1936 Act, that return was deemed to be a notice of assessment. 4 As a result of a client risk review undertaken by the Australian Taxation Office (the ATO), the Commissioner identified certain transactions relating to the merger of the BAT Group and the Rothmans Group as a possible risk to the revenue. The Commissioner issued a position paper to the Taxpayer on 5 May 2005. The Taxpayer provided the Commissioner with a reply to the position paper on 31 October 2005. On 4 August 2006 the Commissioner made a determination that an additional amount of $118,128,983 should be included in the assessable income of the Taxpayer for the 2000 income year. 5 The Commissioner then issued a notice of amended assessment on 9 August 2006. The amended assessment stated that the taxable income of the Taxpayer was $140,841,823. The amended assessment showed an amount payable of $98,326,796.95. That amount included the sum of $42,526,420, representing the tax payable on the understated taxable income and additional tax for understatement of $10,631,605.77, being 25% of the sum of $42,526,420. The adjustment sheet attached to the amended assessment showed the following particulars: Taxable income as returned and assessed $22,718,870 Net capital gain as a result of the Commissioner's determination under section 177F of the 1936 Act $118,128,953 Adjusted taxable income $140,841,823 6 On 3 October 2006, the Taxpayer lodged notice of objection against the amended assessment. On 6 July 2007, the Commissioner made a decision disallowing the objection. That decision was an appellable objection decision and, on 3 September 2007, the Taxpayer commenced this proceeding by way of appeal against that decision. 7 The year in dispute is the 2000 income year. The amount of primary tax in dispute is $42,526,423, being 36% of the tax benefit of $118,128,953 that was the subject of the Commissioner's determination under Part IVA of the 1936 Act. In addition, penalties amounting to $10,631,605 and general interest charge amounting to $36,207,722 are in dispute. The Taxpayer has paid $44,682,875.62 of the total amount in dispute.

THE MERGER OF WILLS HOLDINGS AND ROTHMANS HOLDINGS 8 As at 11 January 1999, when the worldwide merger of the BAT Group and the Rothmans Group was announced, the BAT Group was the second largest tobacco group in the world and Rothmans was the fourth largest. So far as Australia was concerned, the merger involved WD & HO Wills Holdings Limited (Wills Holdings) and Rothmans Holdings Limited (Rothmans Holdings) and their respective subsidiaries. 9 Wills Holdings was a listed public company in Australia. 67.3% of the issued shares of Wills Holdings was held by British American Tobacco Australia Limited (BAT Australia), a subsidiary of BAT UK. The other 32.7% was held by the public. The Taxpayer was a wholly owned subsidiary of Wills Holdings. 10 Rothmans Holdings was also a listed public company in Australia. 50% of its shares were held by Rothmans International and the other 50% were held by the public. Rothmans of Pall Mall (Australia) Limited (Rothmans) was a wholly owned subsidiary of Rothmans Holdings. Rothmans Asia Pacific Limited (Rothmans Asia) was also a wholly owned subsidiary of Rothmans Holdings. PT Rothmans of Pall Mall Indonesia (Rothmans Indonesia) was also a wholly owned subsidiary of Rothmans Holdings. 95% of the issued shares in Rothmans Indonesia were held by Rothmans Asia. 11 In the period prior to the announcement of the merger, Rothmans Indonesia had incurred losses. At the time of the announcement of the merger Rothmans Asia had accumulated capital losses of $63.3 million. 12 Early in the negotiations that led to the merger, it was agreed that the larger of the BAT Group business or the Rothmans Group business in each jurisdiction would take the lead in the merger. In Australia, the Rothmans Holdings group had a larger market share and a larger market capitalisation than the Wills Holdings Group. Accordingly, the Rothmans Holdings group was to take over the Wills Holdings group. In Indonesia, however, PT BAT Indonesia Tbk (BAT Indonesia), which was 70% owned by BAT UK, had a larger market share than Rothmans Indonesia. Accordingly, BAT Indonesia was to acquire Rothmans Indonesia from its Australian owners, Rothmans Holdings and Rothmans Asia. 13 At an early stage, the Australian Competition and Consumer Commission (the Commission) expressed the view that the merger would be likely to have the effect of substantially lessening competition in the cigarette market in Australia and requested the parties to confirm that the merger would not go ahead. Consequently, representatives of Rothmans Holdings engaged in discussions with the Commission concerning the proposed merger. The Commission, through its chairman, Professor Fels, intimated that, without brand divestments by the merged group, the merged entity would become a dominant force in the Australian market after the merger. Professor Fels intimated that, unless there was divestment of some of the brands of the proposed Australian merged group, the Commission would seek to restrain the merger. Professor Fels also intimated that divestment of brands must be on terms that the buyer of the divested brands could be up and running as soon as the brands were transferred to it. 14 Both Wills Holdings and Rothmans Holding wished to satisfy the Commission's requirements because they understood that the Commission could obtain an injunction from the Federal Court preventing completion of the merger. Accordingly, steps were taken to endeavour to find a buyer for some of the brands of the proposed Australian merged group, which could be divested in order to satisfy the Commission's requirements. From an early stage, the group controlled by Imperial Tobacco Group plc (Imperial) was considered as an obvious choice. 15 On 30 April 1999, after some negotiation, an instrument (the Term Sheet) was signed on behalf of BAT UK and Imperial. The Term Sheet provided for the sale and purchase of a number of Australian and New Zealand cigarette brands, tobacco brands and tobacco paper brands, together with the related intellectual property rights and know how related to those brands. Some of the brands were Wills brands and some were Rothmans brands. The sellers named in the Term Sheet were the Taxpayer, British American Tobacco (New Zealand) Limited (BAT NZ) and Rothmans Holdings. The buyer named in the Term Sheet was Imperial. The purchase price was to be the sum of $A325 million and the sale was to include assets necessary for the functioning of the sales force for the brands to be sold. 16 Completion of the proposed sale to Imperial was to be subject to shareholder approvals and to completion of the merger of Wills Holdings and Rothmans Holdings. The Term Sheet expressly recognised that the parties would work together to achieve as efficient a structure for the transaction as may be possible and that that might affect who would be the vendors and who would be the purchasers of the relevant brands. 17 During April and May 1999, negotiations took place concerning the implementation of the merger in Australia. In particular, negotiations took place as to the price that would be paid to the minority shareholders of Wills Holdings. The negotiations resulted in an accord in principle, which was recorded in a letter of 13 May 1999 from BAT UK to Wills Holdings. The directors of Wills Holdings were satisfied that they had secured a significant cash premium for the minority shareholders. 18 On 19 May 1999, a memorandum of understanding in relation to the implementation of the merger in Australia was signed on behalf of BAT UK, Rothmans Holdings (Australia) (BV), Wills Holdings and Rothmans Holdings (the Memorandum of Understanding). The Memorandum of Understanding recited, inter alia, that the Commission had foreshadowed that, as a condition of its approval of the merger, the merged group must dispose of certain assets. Clause 3.1 provided that Rothmans Holdings would, immediately upon entry into the Memorandum of Understanding, procure that Rothmans would negotiate in good faith with Imperial to agree option arrangements as follows: · Rothmans would irrevocably offer to sell to Imperial the assets identified in the Term Sheet. · Imperial would irrevocably offer to purchase from Rothmans the assets identified in the Term Sheet. Each of those irrevocable offers was to be subject to the condition precedent that the Australian merger be successfully implemented. The Memorandum of Understanding also dealt with other details relating to the merger that are not presently relevant. 19 On 2 June 1999, BAT UK, BAT Australia and Rothmans Holdings (the Merger Parties) executed an enforceable undertaking to the Commission (the Commission Undertaking). On the same day, the Commission Undertakings were accepted by Professor Fels on behalf of the Commission. Rothmans Holdings and Wills Holdings immediately announced that they welcomed the Commission's clearance of the proposed merger on the basis of the proposed sale of brands. 20 By the Commission Undertaking, each of the Merger Parties agreed to do all things in its power or control to cause or procure the disposal of the business of manufacturing, marketing, selling and distributing cigarettes and other tobacco products under the brand names listed in a schedule to the Commission Undertaking. The brand names listed in that schedule were the brand names stated in the Term Sheet. Each of the Merger Parties also agreed to cause or procure entry into a series of contractual arrangements with Imperial as described in another schedule to the Commission Undertaking. Each of the Merger Parties undertook to give effect to those contractual arrangements in accordance with their terms. 21 On 16 July 1999, Wills Holdings, Rothmans Holdings and BAT Australia entered into a Merger Implementation Agreement. The Merger Implementation agreement provided detailed mechanisms and arrangements to give effect to the proposed merger of the Australian groups. 22 On 20 July 1999, Wills Holdings and Rothmans Holdings announced the conditional sale of brands to Imperial. On the same day, Rothmans Holdings executed a deed whereby it covenanted with Imperial that it would comply with the terms of the Commission Undertaking and would comply with the terms of the contractual arrangements described in the Commission Undertaking. 23 In addition, on the same day, Rothmans and Imperial and the Taxpayer entered into an instrument entitled Offers for Sale and to Acquire Australian brands (the Offer Instrument). By the Offer Instrument, Rothmans irrevocably offered to sell to a subsidiary of Imperial, nominated by it, certain Australian intellectual property assets and Imperial irrevocably offered to procure the acquisition, by one of its subsidiaries, from Rothmans of those Australian intellectual property assets. The Australian intellectual property assets included nine Australian brands owned at that time by the Taxpayer (the 9 Wills Brands) as well as Australian brands owned by Rothmans. The sale and acquisition was to be on the terms of an agreement in the form annexed to the Offer Instrument. 24 Clause 3.5 of the Offer Instrument provided that, if either offer was accepted, Rothmans and the subsidiary nominated by Imperial would be deemed to have entered into a binding and enforceable agreement for the sale and purchase of the Australian intellectual property assets on the terms of the agreement annexed to the Offer Instrument (the Australian Brands Sale Agreement). The date of such agreement was to be the date of acceptance of the relevant offer. Clause 3.1 of the Offer Instrument provided that neither offer would be capable of acceptance unless the conditions precedent specified in the Offer Instrument had been satisfied or the conditions had been waived and unless the Implementation Date, as defined in a proposed scheme of arrangement between Wills Holdings and certain of its members, had occurred. 25 On 16 July 1999, the Supreme Court of New South Wales ordered that a meeting of members of Wills Holdings be convened for the purpose of considering a scheme of arrangement under which Wills Holdings would buy back all shares in Wills Holdings held by BAT Australia and Rothmans would acquire all of the shares in Wills Holdings held by other shareholders for the consideration stated in the scheme. At the meeting so convened, which was held on 18 August 1999, the shareholders of Wills Holdings voted in favour of a resolution to approve that scheme of arrangement. On the same day, the shareholders of Rothmans Holdings also voted in favour of a scheme of arrangement between Rothmans Holdings and its shareholders. On 2 September 1999, the merger of Rothmans Holdings and Wills Holdings was completed in accordance with the schemes of arrangement. 26 On 3 September 1999 several instruments were entered into and completed to give effect to the merger of the Wills Group and the Rothmans Group. In particular, the Taxpayer, as assignor, and Rothmans, as assignee, entered into a deed of assignment, for a consideration of $181,700,000, of the 9 Wills Brands. Thereupon, following exercise of the options under the Offer Instrument, Rothmans as seller, on the one hand, and Pinelawn, an Irish corporation, Imperial New Zealand Limited and Van Nelle Tabak Nederland BV, as buyers, on the other hand, entered into the Australian Brands Sale Agreement. The three buyers are subsidiaries of Imperial. Each of those entities purchased different brands from Rothmans. The brands sold included the 9 Wills Brands. In due course the Australian Brands Sale Agreement was completed and the 9 Wills Brands and the relevant Rothmans brands were transferred to one or other of the three buyers. The consideration received by Rothmans in respect of the sale of the 9 Wills Brands to the three buyers was the same as that received by the Taxpayer from Rothmans, namely $181,700,000.

TAX PLANNING IN RELATION TO THE 9 WILLS BRANDS 27 Evidence concerning the merger was given by affidavit on behalf of the Taxpayer. No objection was taken by the Commissioner to any of the affidavits and there was no cross examination of any of the deponents. 28 Mr Martin Broughton became chairman of BAT UK in 1998 when that company was first listed on the London Stock Exchange. Mr Broughton was also the chairman of the management board to which the strategic management of BAT UK was delegated. During the second half of 1998, representatives of BAT UK participated in negotiations with RJ Reynolds of the United States, in relation to the possible purchase of that company's tobacco business. At the same time, representatives of Rothmans International were also talking to RJ Reynolds about the possibility of purchasing its tobacco business. Mr Broughton described RJ Reynolds as, in effect, running an auction for its business between Rothmans International and BAT UK. In November 1998, Mr Broughton met with Mr Johann Rupert, the chief executive officer of Richemont. Mr Broughton considered that a merger with Rothmans was an attractive option and in due course the merger proposal was announced on 11 January 1999. 29 In 1998 and 1999, Mr Gary Krelle was the chief executive officer of Rothmans Holdings. In that capacity, Mr Krelle was a member of the executive committee of Rothmans International. At a meeting in South Africa in November 1998, Mr Krelle participated in a discussion about a possible bid by Rothmans International for the non-United States business of RJ Reynolds. In early January 1999, Mr Krelle was informed that the Rothmans International bid for RJ Reynolds was unsuccessful but that the Rothmans Group would be merging with BAT Group. 30 In 1998, Mr Nigel Gourlay was appointed head of business development of BAT UK. In his role as head of business development he reported to Mr Broughton on global and regional projects and to Mr Ulrich Herter, the managing director of BAT UK, on national projects. Mr Gourlay was responsible for new markets around the world where the BAT Group had no presence or had only a limited presence. 31 Mr Gourlay was lead negotiator for BAT UK in the discussions with Rothmans International. His counterpart was Elois Mishotte of Rothmans. The negotiations began in late 1998 and progressed quickly until the announcement of the merger on 11 January 1999. Once the public announcement of the merger was made, Mr Gourlay's role was to ensure the global completion of the merger. Specifically, he had the role of ensuring that all of the requisite regional mergers were effected in order to implement the merger world wide. That included the merger of any public companies. Australia was the most complex of the world wide jurisdictions. 32 Mr Gourlay was a member of the merger integration steering group led by Ulrich Herter. The steering group consisted of senior employees of the BAT Group and the Rothmans Group. The steering group was important in the first few weeks after the merger was announced in setting out the rules of engagement between the Rothmans Group and the BAT Group. It also set out the communication process and many of the different task forces and teams that were necessary to progress the local mergers as quickly and efficiently as possible. 33 The steering group did not formally report to the Board of BAT UK. However, members of the steering group, including Mr Gourlay, spoke to Mr Broughton as and when required. Mr Gourlay described the principles laid down by the steering group as follows: · To bolt together the different BAT Group and Rothmans International companies as quickly and sensibly as possible, with the company with the largest market share in a jurisdiction taking the lead in that jurisdiction. · To achieve profit target in accordance with the 1999 company plans. · To look for merger synergies. 34 Where public companies were involved in a particular jurisdiction, minority shareholders had to be considered. Australia was difficult because the requirements of the Australian Securities and Investments Commission, as well as the Australian Competition and Consumer Commission, had to be satisfied. Mr Gourlay understood that Australia was the only jurisdiction where the regulatory authorities could potentially obtain an injunction to prevent the global merger occurring. 35 Ideally, Mr Gourlay wanted the Commission to agree that the merger could proceed on the basis that competition issues would be dealt with in the future, on the basis of undertakings. Mr Gourlay understood that the Canadian authorities were willing to allow the merger of the Canadian entities to proceed on that basis, but that the Commission was not prepared to allow the merger of the Australian entities to proceed on that basis. He understood that the Commission required a brand disposal deal to be signed with a robust and credible competitor before the merger could proceed. He understood that merely putting forward a buyer who was not already in the tobacco industry would not have satisfied the Commission. 36 In 1998, Mr Kenneth Hardman became head of taxation of BAT UK and is still employed as head of tax for the merged British American Tobacco group of companies. In that role, he has ultimate responsibility for all taxation matters for the group world wide. During the last quarter of 1998, Mr Hardman was involved in discussions with Richemont relating to the proposed merger of the BAT Group with the Rothmans Group. In relation to tax issues on the merger, Mr Hardman reported to Messrs Broughton and Herter and Keith Dunt. 37 Mr Hardman understood that the Commission was likely to require the merged entity to dispose of assets to a third party as a condition of the Commission's not seeking an injunction to prevent the implementation of the global merger. While Mr Hardman was not involved in the selection of the brands to be sold, he was informed about the progress of negotiation and the evaluation exercise conducted in relation to those brands. The method by which the brands were to be divested by the merged group was determined after the corporate structure of the merged Australian groups had been agreed. 38 Mr John Kingsley, who has since died, was the chief finance officer of Rothmans Holdings. Mr David Leach was chief finance officer of Wills Australia and Mr Barry Cohen was tax manager of Wills Australia. Mr Mark Dunkley was the group taxation manager. Messrs Kingsley, Dunkley, Leach and Cohen kept Mr Hardman appraised of progress with the method proposed to effect the required divestment of brands. 39 In a memorandum of 20 May 1999, Mr Kingsley outlined to Mr Hardman the method he proposed to effect the divestment of brands. The memorandum recorded the substance of a proposal that had been explained to Mr Hardman by Mr Kingsley orally, prior to the signing of the Memorandum of Understanding. Mr Kingsley proposed that, once Wills Holdings became a wholly owned subsidiary of Rothmans Holdings, the 9 Wills Brands would be transferred at market value to Rothmans. Mr Kingsley explained that, since the Taxpayer would then be a wholly owned subsidiary of Rothmans, the Taxpayer could exercise an election to rollover any capital gains liability from the Taxpayer to Rothmans. He explained that, while the divestment of brands by Rothmans to Imperial at market value would give rise to a capital gain by Rothmans, losses were available to Rothmans, including carried forward capital losses and current year losses, to set off against that capital gain. 40 Mr Hardman agreed to Mr Kingsley's proposal for the following reasons: · The requirement for divestiture was imposed upon the merged group by the Commission. · The merged group had available capital losses to offset any capital gain arising on the forced sale of brands. · Australian taxation law provided a specific election to enable companies within the same corporate group to enjoy rollover relief upon transfers within that corporate group. · If a capital gain arose in the merged corporate group, available capital losses could be used to shelter that capital gain. · There was no commercial sense for the merged group to effect the required divestiture in a way that did not utilise the capital losses available to the merged group. Mr Hardman considered that Mr Kingsley had produced a solution for a potential tax liability arising on the disposal of brands to the Imperial Group. Accordingly, he did not consider it necessary to consult Mr Broughton or Mr Herter about the issue. 41 In a memorandum to Mr Kingsley of 20 May 1999, Mr Dunkley expressed concern that agreements might be entered into for the sale of the brands prior to the merger taking place. Mr Dunkley said that it appeared to him that there may be instances of the BAT Group and Imperial entering into negotiations and preliminary agreements that could give rise to a question as to whether a brand disposal had taken place at a date prior to the merger occurring. While Mr Dunkley did not believe that their arguments had been jeopardised to date, he thought it was important that Mr Hardman be advised of the steps that needed to be undertaken in order to be in a position to utilise the tax losses that would exist in Rothmans Asia. Mr Dunkley prepared a memorandum for Mr Kingsley to send to Mr Hardman. 42 In that memorandum, which Mr Kingsley sent to Mr Hardman on 20 May 1999, Mr Kingsley first described the current position. He said that Rothmans Asia had carried forward capital losses of $63.3 million that arose from the sale of an investment in the Philippines. As a result of the sale of Rothmans Indonesia, a capital loss of in excess of $100 million would also arise in Rothmans Asia. In total, therefore, the Rothmans Holdings group had in excess of $163 million of capital losses, which could be utilised and set off against capital gains arising in the Rothmans Holdings group. 43 Mr Kingsley then outlined a strategy for utilising the capital losses as follows: · Complete the merger prior to entering into any contractually binding agreements for the sale of any brands to Imperial. · Transfer the 9 Wills Brands to Rothmans: while that would give rise to a stamp duty liability, no capital gain would be generated, as a rollover would be available in respect of assets transferred between group companies. · Complete the contractually binding agreements between Rothmans and Imperial for the disposal of all brands, including the 9 Wills Brands, giving rise to a significant capital gain in Rothmans. · Transfer the available capital losses from Rothmans Asia to Rothmans. 44 Mr Kingsley identified a critical issue. He said that the need to ensure that there was no contractually binding agreement for the disposal of the 9 Wills Brands prior to the Taxpayer and Rothmans becoming part of the same group was of critical importance to the strategy for utilising the losses. He said that, if a disposal of the 9 Wills Brands occurred prior to the Wills Group being wholly owned by the Rothmans Groups, the rollover would be ineffective, a capital gain arising from the disposal of the 9 Wills Brands would be generated in the Taxpayer and it would not be possible to transfer the capital losses in the Rothmans Group to the Taxpayer. Mr Kingsley therefore urged Mr Hardman to monitor the creation of contracts and documentation in the United Kingdom that relate to the disposal of the 9 Wills Brand to Imperial. He said that failure to do so could significantly jeopardise the ability to maximise the utilisation of the capital losses that existed in the Rothmans Group.

THE COMMISSIONER'S INVESTIGATIONS 45 On 16 May 2001, an officer of the ATO telephoned Ms Donna Rubbo of the British American Tobacco Australia Group, the merged group (the Merged Group), and informed her that the ATO was currently undertaking a client risk assessment in relation to the Merged Group. Ms Rubbo indicated that she would prefer if the ATO could make an informal approach to her by email rather than by a formal letter. Accordingly, the ATO sent an email to Ms Rubbo confirming a request for information in relation to named members of the Merged Group, including Rothmans. The ATO requested schedules detailing calculation of capital gains or losses. 46 On 6 July 2001, Mr Dunkley responded to the email and enclosed documents relating to the companies named in the ATO's email. Mr Dunkley referred to the fact of the merger that had been completed in September 1999, which gave rise to the Merged Group. Mr Dunkley also pointed out a number of name changes undergone by members of the Merged Group. He also said, in relation to the request for information in relation to capital gains and losses, that schedules had been included in the income tax working papers where appropriate but that there were no significant gains or losses arising to the Merged Group during the relevant period, with the exception of the 2000 income year return for Rothmans. Additional work papers were included with the documents in support of the capital gains tax calculation for Rothmans for that year. On 16 July 2001, Mr Dunkley forwarded further documents to the ATO. 47 On 6 March 2002, the ATO wrote again, requesting further details relating to specific transactions involved in the merger between Rothmans Holdings and Wills Holdings and the subsequent disposal of brands to Imperial. Specifically, the letter requested information and documentation as follows: · a chronological record of all material transactions undertaken leading up and through to the completion of the merger; · all contracts and other associated agreements; · minutes of all board meetings; · a copy of documentations supplied to shareholders; · details of capital gains tax assets sold. Mr Dunkley replied on 8 April 2002 and enclosed material in response to that request. Mr Dunkley said to the ATO that, while the information provided explained the merger, it did not fully satisfy all of the information requested in the letter of 6 March 2002. 48 On 30 May 2002, arrangements were made between Mr Dunkley and the ATO for a visit to the offices of the Merged Group by officers of the ATO on 18 and 19 June 2002. On 31 May 2002, an email was sent by the ATO to Mr Dunkley confirming a request by the ATO that contracts and board minutes be available for inspection during the proposed visit. 49 On 5 September 2002, the ATO wrote to Mr Dunkley with reference to the client risk review of the Merged Group that had been conducted by the ATO. The letter said that the client risk review had been completed and attached details of material tax risks identified by the ATO. The letter said that, based on the information provided in the process of review, the ATO was requesting further documentation and information in respect of relevant transactions. An annexure to the letter specifically asked for details of the purpose, commercial or otherwise, for the transfer of the 9 Wills Brands by the Taxpayer to Rothmans prior to their disposal to Imperial. The ATO specifically asked for provision of "the reason why this additional step was undertaken". The ATO's letter referred to s 177D of the 1936 Act. 50 Mr Dunkley replied on 23 September 2002. An annexure to his letter dealt specifically with the transfer of the 9 Wills Brands from the Taxpayer to Rothmans prior to the disposal to Imperial. Mr Dunkley said that the reasons for the transfer of the 9 Wills Brands by the Taxpayer to Rothmans were as follows: · The 9 Wills Brands were eventually sold to Imperial as required by the Commission; therefore, transferring the 9 Wills Brands to Rothmans was consistent with a clearly defined and consistent strategy of having all brands packaged into a single vendor entity. · Packaging all of the brands into a single entity was seen as important from a logistical perspective because, unless the brands were transferred to a single entity, there would be a number of different vendor parties. Further, there were timing constraints concerning the disposal of the brands to Imperial, which were dictated by the pressure from the United Kingdom regarding the timing of the global merger and the need to ensure the merger in Australia was completed as soon as possible after 2 June 1999. Accordingly, it was important to have only a single party to negotiate the terms of the sale of brands with Imperial, to minimise delays and difficulties. · It was logical for the entity that was selling the brands to Imperial to be Rothmans, because Rothmans Holdings was the surviving entity after the merger and Rothmans was the entity that was selling the majority of the Australian Rothmans brands to Imperial; accordingly, other Rothmans brands were also transferred to Rothmans from other companies within the Rothmans group, consistently with the brands being packaged into a single entity for their sale to Imperial. · In order to comply with the Commission's requirements, Rothmans entered into a contract manufacturing agreement with Imperial in respect of the divested brands; having a single vendor, being a Rothmans Holdings entity, was consistent with the agreements entered into with Imperial. · In the subsequent rationalisation of the various companies within the Merged Group, assets required for the ongoing manufacture of tobacco products were transferred to Rothmans. · Accordingly, the transfer of the 9 Wills Brands to Rothmans prior to their sale to Imperial was consistent with perceived longer term end strategy for the merged group. 51 Mr Dunkley's response ended by saying that the disposal of brands to Imperial was an important feature of the merger, and had been implemented to comply with the requirements of the Commission. He said that that was why the ultimate disposal of brands to Imperial was conditional on the merger being approved by shareholders. He emphasised that the process involving the disposal of brands to Imperial was driven by a need to comply with the Commission's requirements and the packaging was something that was a consistent part of the strategy to ensure that the requirements of the Commission could be complied with in the most simple and effective way. 52 On 13 November 2002, the ATO informed Mr Dunkley that it was considered appropriate to escalate the review of the Merged Group to a large business audit, which would focus on, but not necessarily be restricted to, the material risks identified in the ATO's letter of 5 September 2002. It is common ground that, by the letter of 13 November 2002, the Commissioner informed the Taxpayer, for the first time, that a tax audit relating to the Taxpayer was to be carried out. The significance of that will become apparent.

RELEVANT STATUTORY PROVISIONS 53 Different provisions are relevant to the questions of assessability and penalty. I shall deal with each separately.

Assessability 54 Subdivision 126-B of the Income Tax Assessment Act 1997 (Cth) (the 1997 Act) sets out when a company can obtain a rollover if it transfers a CGT asset to another company that is a member of the same wholly owned group. Under s 126-45(1), which is in subdivision 126-B, there may be a rollover if a CGT event (the trigger event) happens involving a company (the originating company) and another company (the recipient company) where, relevantly, the originating company and recipient company are members of the same wholly owned group at the time of the trigger event. 55 Under s 126-55, there is a rollover if, relevantly: · the trigger event would have resulted in the originating company making a capital gain, and · the originating company and recipient company both choose to obtain the rollover. Under s 126-60, the consequence of rollover is that a capital gain that the originating company makes from the trigger event is disregarded. 56 Part IVA of the 1936 Act, which consists of ss 177 to 177F, deals with schemes to reduce income tax. Scheme is defined in s 177A(1) as meaning: · 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 · any scheme, plan, proposal, action, course of action or course of conduct. 57 Under s 177F(1), where a tax benefit has been obtained, the Commissioner may, in the case of a tax benefit that is referable to an amount not being included in the assessable income of a taxpayer, determine that the whole or part of that amount is to be included in the assessable income of the taxpayer. Under s 177F(2), where the Commissioner determines that an amount is to be included in the assessable income of a taxpayer, that amount is to be deemed to be included in that assessable income by virtue of such provision of the 1936 Act as the Commissioner determines. 58 Under s 177D, Part IVA relevantly applies to any scheme where a taxpayer has obtained a tax benefit in connection with the scheme and, having regard to the matters referred to in s 177D(b), it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for the purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme. The matters referred to in s 177D(b) are as follows: (i) the manner in which the scheme was entered into or carried out; (ii) the form and substance of the scheme; (iii) the time at which the scheme was entered into and the length of the period during which the scheme was carried out; (iv) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme; (v) any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme; (vi) any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme; (vii) any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out; and (viii) the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (vi); 59 Section 177C(1)(a) relevantly provides that a reference in Part IVA to the obtaining by a taxpayer of a tax benefit in connection with a scheme is to be read as a reference to an amount not being included in the assessable income of the taxpayer where that amount would have been included, or might reasonably be expected to have been included, in the assessable income of the taxpayer if the scheme had not been entered into or carried out. However, under s 177C(2A), a reference to the obtaining by a taxpayer of a tax benefit in connection with a scheme is, in some circumstances, to be read as not including a reference to the assessable income of a taxpayer not including an amount that would have been included, or might reasonably be expected to have been included, in the assessable income of the taxpayer, if the scheme had not been entered into or carried out. 60 Under s 177C(2A)(a), the relevant circumstances are where: (i) the non-inclusion of the amount of the assessable income of the taxpayer is attributable to the making of a choice under subdivision 126-B of the 1997 Act; and (ii) the scheme consisted solely of the making of the election. For the purposes of s 177C(2A), the non-inclusion of an amount in the assessable income of a taxpayer is taken to be attributable to the making of an election where, if the election had not been made, the amount would have been included in that assessable income. The language of the provision is unfortunate. Having referred to the making of a choice under subdivision 126-B, the provision then refers to the making of the "…election". There may be historical reasons explaining that disconformity. The proceeding has been conducted on the basis that the reference to election in s 177C(2A)(a)(ii) is s reference to the same thing as the choice referred to earlier, in s 177C(2A)(a)(i). Clearly enough, the reference to the election in s 177C(2A)(a)(ii) must be understood as a reference to the choice referred to in s 177C(2A)(a)(i).

Penalty 61 Part VII of the 1936 Act, as then in force, relates to Penalty Tax. Section 226(1), which is in Part VII, relevantly provides that, where: · the Commissioner has calculated the tax that is assessable to a taxpayer (see s 226(1)(a)), · a determination made by the Commissioner under s 177F(1) was taken into account in calculating the tax (see s 226(1)(b)) and · the amount of tax that would have been assessable to the Taxpayer in relation to the year of income if no determination had been made is less than the amount of tax that the Commissioner has calculated as assessable (see s 226(1)(c)(ii)), the Taxpayer is liable to pay additional tax, by way of penalty, equal to the penalty percentage, of the amount by which the amount of tax calculated by the Commissioner exceeds the amount of claimed tax. Under s 226(2)(b), penalty percentage means 25% in the present case because it is common ground that it is reasonably arguable that Part IVA does not apply in this case. 62 However, under s 226E, if a taxpayer is liable to pay additional tax under a scheme section and, before the Commissioner had informed the taxpayer that a tax audit relating to the taxpayer in respect of the relevant income year was to be carried out, the Taxpayer voluntarily told the Commissioner in writing about the matter because of which the wrongful behaviour provision applies, the amount of the additional tax is to be reduced by 80%. Under s 222A, s 226 is a scheme section and s 226(1)(c)(ii) is a wrongful behaviour provision.

ISSUES 63 The issues in relation to assessability are as follows: · Whether the scheme as identified by the Commissioner is a scheme within the meaning of that word as used in s 177A(1) of the 1936 Act. · Whether, in the 2000 income year, the amount of $118,128,953 is an amount of assessable income that would have been included, or might reasonably be expected to have been included, in the assessable income of the Taxpayer if the scheme as so identified had not been entered into or carried out. · Whether s 177C(2A)(a) of the 1936 Act applies, such that the Taxpayer did not obtain a tax benefit in connection with the scheme as so identified. · Whether, having regard to the eight matters identified in s 177D, it would be concluded that a person, or one of the persons, who entered into or carried out the scheme as so identified, or any part of that scheme, did so for the purpose of enabling the Taxpayer to obtain the relevant tax benefit in connection with the scheme so identified. 64 There is no factual dispute as to the objects of the global merger between the BAT Group and the Rothmans Group or the fact of that global merger in Australia. However, while the agreements by which the global merger was implemented give rise to no factual dispute, there are issues as to the conclusions that should be drawn concerning: · the deliberations of and negotiations between the various members of the BAT Group and the Rothmans Group in relation to the inter-group disposals and acquisitions of the 9 Wills Brands; and · the deliberations of and negotiations between the various members of the BAT Group and the Rothmans Group, on the one hand, and the members of the Imperial Group, on the other hand, in relation to the acquisition by members of the Imperial Group of the 9 Wills Brands. 65 The first issue raised in relation to penalty tax is whether, before receipt of the ATO's letter of 13 November 2002, the Taxpayer had told the Commissioner, by reason of the exchanges described above, about the matter because of which s 226 applied to the Taxpayer. The second issue is whether, if that prerequisite was satisfied, the exchanges described above constituted the Taxpayer telling the Commissioner voluntarily.

ASSESSABILITY 66 As indicated above, there are four issues concerning the disputed assessment, apart from the question of penalty. It is convenient to deal with each assessability issue separately.

Scheme 67 The Commissioner contends that the following steps comprise a scheme in connection with which the Taxpayer obtained a tax benefit: · the decision to interpose Rothmans between the Taxpayer and the members of the Imperial Group in relation to the disposal of the 9 Wills Brands from the Taxpayer to the members of the Imperial Group; · the disposal of the 9 Wills Brands from the Taxpayer to Rothmans; · the disposal of the 9 Wills Brands from Rothmans to the members of the Imperial Group; · the making of the choices by the Taxpayer and Rothmans to obtain rollover in relation to the capital gains made by the Taxpayer as a result of the disposal of the 9 Wills Brands to Rothmans; · the making of agreements for the transfer of net capital losses between Rothmans Holdings and Rothmans Asia as transferors, on the one hand, and Rothmans as transferee, on the other, including net capital losses arising as a consequence of agreements to dispose and the disposal by Rothmans Holdings and Rothmans Asia of their respective shareholdings in Rothmans Indonesia; · the utilisation by Rothmans of the net capital losses transferred from Rothmans Holdings and Rothmans Asia for the purposes of the calculation by Rothmans of its net capital gain for the 2000 year of income; · the utilisation by Rothmans of a net capital loss carried forward from an earlier year of income for the purposes of the calculation by Rothmans of its net capital gain for the 2000 year of income. 68 The Taxpayer says that the only step to which the non-inclusion of $118,128,953 in the Taxpayer's assessable income is attributable, in the sense required by s 177C(1)(a), is the step involving the making of choices by the Taxpayer and Rothmans, after the Taxpayer and Rothmans had become part of the same group, to obtain rollover relief in relation to the capital gains made by the Taxpayer as a consequence of the assignment of the 9 Wills Brands to Rothmans pursuant to s 126-55(1)(b) of the 1997 Act. The Taxpayer says that the only other step that might be part of a scheme for the purposes of s 177C(1)(a) is the step involving the disposal of the 9 Wills Brands from the Taxpayer to Rothmans. The Taxpayer says that the other steps identified by the Commissioner are not part of a scheme in connection with which the tax benefit in question could have been obtained, because they did not result in that tax benefit. That is to say, the Taxpayer contends that the relevant scheme must be limited to the steps necessary to effect the rollover under subdivision 126-B on the disposal of the 9 Wills Brands to Rothmans. The significance, on the Taxpayer's contention, is that s 177C(2A)(a) would then operate to remove the asserted tax benefit from the operation of Part IVA. 69 The definition of the scheme is important, since any tax benefit identified must be related to the scheme, as must any conclusion of dominant purpose and the ultimate determination by the Commissioner (Commissioner of Taxation v Hart (2004) 217 CLR 216 at [5]). The definition in s 177A is wide, but it must be related to the tax benefit obtained (Hart at [9]). On the other hand, scheme is defined in s 177A(1) in terms that may not always permit the precise identification of what are said to be all of the integers of a particular scheme. The definition encompasses not only a series of steps that together can be said to constitute a scheme or a plan but also the taking of but one step. The very breadth of the definition is consistent with the objective nature of the enquiries that are to be made under Part IVA (Hart at [43]). The bare fact that a taxpayer pays less tax, if one form of transaction rather than another is made, or simply to show that a taxpayer has obtained a tax benefit does not demonstrate that Part IVA applies. Thus, it is necessary to read Part IVA in a way that will not bring ordinary transactions to tax. Of course, the significance of such a proposition depends upon what is meant by ordinary (Hartat [53]). 70 The question is whether that which the Commissioner has identified as the scheme falls within the definition in s 177A. That is to say, it is necessary to determine whether all of the steps leading to and the entering into and the implementation of the disposal of the 9 Wills Brands by the Taxpayer to Rothmans can be understood as together constituting a scheme. The question is whether those steps constituted a scheme, plan or course of action (Hart at [55]). 71 The essence of the scheme identified by the Commissioner is the disposal of the 9 Wills Brands by the Taxpayer to Rothmans and their subsequent disposal by Rothmans to the Imperial Group, coupled with the exercise of the rollover choice by the Taxpayer and Rothmans, and the utilisation by Rothmans of losses in the Rothmans Group. That is to be contrasted with the counterfactual hypothesis, of a disposal of the 9 Wills Brands by the Taxpayer directly to the Imperial Group with the consequence that the Taxpayer's capital gain would be the income of the Taxpayer. 72 The negotiations between BAT UK and Imperial culminated in the execution of the Term Sheet on 30 April 1999. The arrangements covered by the Term Sheet included the disposal of the 9 Wills Brands. Although the arrangement was conditional upon, inter alia, the completion of the merger and took account of the possibility of changes in the identity of the relevant vendors and purchasers, there was no legal or commercial reason why the 9 Wills Brands could not have been disposed of by the Taxpayer directly to Imperial's subsidiaries rather than being disposed of to Rothmans and then disposed of by Rothmans to Imperial's subsidiaries, as happened. 73 The Taxpayer did not enter into any agreement with Rothmans with respect to the disposal of the 9 Wills Brands until 3 September 1999, after the completion of the merger had taken place. That is so even though, as early as 30 April 1999, the date of the Term Sheet, plans for the acquisition of the 9 Wills Brands by Imperial were in place. It was not until 3 September 1999 that the Taxpayer disposed of the 9 Wills Brands to Rothmans for the consideration of $181,700,000. That was the day after completion of the merger pursuant to the schemes of arrangement. That sequence had the effect of avoiding possible adverse capital gains tax consequences for the Taxpayer. 74 The parties wanted to ensure that there would be a disposal to Imperial or its nominees. Accordingly, on 20 July 1999, Rothmans and the Taxpayer, on the one hand, and Imperial, on the other, had entered into the Offer Instrument whereby irrevocable offers to sell and to buy the 9 Wills Brands were granted. The adoption of that mechanism, in lieu of an actual sale and purchase, had the effect that capital losses would be available to set off against gains rolled over to Rothmans. The arrangement was conditional upon, inter alia, completion of the merger pursuant to the schemes of arrangement. Once again, it was not until 3 September 1999 that the members of the Imperial Group accepted the offer of Rothmans under the Offer Instrument. Assignment deeds were then executed to give effect to the Australian Brands Sale Agreement that had come into existence by reason of the acceptance of the offer. As I have said, the consideration received by Rothmans in respect of the assignment of the 9 Wills Brands to the members of the Imperial Group was the same as that received by the Taxpayer from Rothmans, namely $181,700,000. 75 Rothmans made a capital gain on the disposal of five of the 9 Will Brands, aggregating $138,328,953. Rothmans made a capital loss on the disposal of three of the 9 Wills Brands, aggregating $20,200,000 and made no capital gain or capital loss on the disposal of one of the 9 Wills Brands. Thus, the net capital gain of Rothmans was $118,128,953. 76 In their respective income tax returns for the 2000 income year, the Taxpayer and Rothmans chose rollover pursuant to subdivision 126-B in relation to the CGT events that occurred by reason of the disposal by the Taxpayer to Rothmans of the 9 Wills Brands. Rothmans Holdings, Rothmans Asia and Rothmans were all members of the Rothmans Holdings group and, accordingly, it was open for Rothmans Holdings and Rothmans Asia to transfer net capital losses to Rothmans. Rothmans Holdings and Rothmans entered into an agreement for the transfer by Rothmans Holdings to Rothmans of the net capital loss of $341,043 in respect of the 2000 income year and Rothmans Asia and Rothmans entered into an agreement for the transfer of Rothmans Asia to Rothmans of a net capital loss of $161,977,127 in respect of the 2000 income year. 77 Accordingly, in calculating net capital gains, and thus its assessable income, for the 2000 income year, Rothmans was able to utilise the capital losses transferred to it from the other members of the Rothmans Holdings group. Rothmans applied the net capital losses transferred to it by Rothmans Holdings and Rothmans Asia in working out the amount of its net capital gains and the amount of its assessable income for the 2000 income year. Rothmans had a net capital loss of $361,073 that was carried forward from an earlier income year into the 2000 income year. Rothmans applied that loss in working out its net capital gain and thus its assessable income for the 2000 income year. 78 The essence of the scheme consisted of the arrangement whereby the 9 Wills Brands were disposed of by the Taxpayer to Rothmans and then by Rothmans to the Imperial Group, after there had been a rollover choice to enable the Taxpayer to avoid capital gains tax. The capital losses were then transferred to enable Rothmans to avoid capital gains tax. I consider that the steps identified by the Commissioner, which are described above, constitute a scheme for the purposes of Part IVA.

Tax Benefit 79 Members of the Rothmans Holdings group, prior to the merger, had existing capital losses, including capital losses carried forward in Rothmans Australia arising from the sale of an investment in the Philippines. The sale by Rothmans Holdings and Rothmans Asia of their respective shares in Rothmans Indonesia to BAT Indonesia also generated further capital losses. Those capital losses were never capable of transfer to the Taxpayer. They were only capable of transfer to companies that, prior to the merger, were members of the Rothmans Holdings group, including Rothmans. 80 Had the scheme not been entered into or carried out as described but the same ultimate result, disposition of the 9 Wills Brands to the Imperial Group, were to be achieved or effected, the Taxpayer would have derived the capital gain on the disposal of five of the 9 Wills brands, would have made a capital loss on the disposal of three of them and would not have made a capital gain or loss on the disposal of one of them. Thus, the Taxpayer would have derived a net capital gain of $118,128,953 on the disposal of the 9 Wills Brands to the Imperial Group. There is no reason to doubt that, if the scheme had not been implemented or carried out, the 9 Wills Brands would nevertheless have been disposed of by the Taxpayer direct to the Imperial Group subsidiaries in order to satisfy what was perceived to be a necessary requisite for the completion of the merger of Wills Holdings and Rothmans Holdings. 81 The Taxpayer obtained a tax benefit within s 177C(1)(a) of the 1936 Act in the 2000 income year. The tax benefit was the non-inclusion of an amount of $118,128,953 as a capital gain in determining the Taxpayer's assessable income pursuant to s 102-5 of the 1997 Act. The Taxpayer obtained that tax benefit because, had the scheme identified above not been entered into or carried out, that sum of $118,128,953 would have been included in its assessable income in the 2000 income year as a net capital gain pursuant to s 102-5 of the 1997 Act. I consider that the Taxpayer obtained that tax benefit in connection with the scheme identified by the Commissioner and described above.

Section 177C(2A)(a)(ii) 82 The Taxpayer says that the choice of rollover, pursuant to subdivision 126-B, in relation to the CGT events consisting of the disposal of the 9 Wills Brands by the Taxpayer to Rothmans, and only that, if anything, constituted a scheme for purposes of Part IVA. The Taxpayer contends that, therefore, s 177C(2A)(a) applies to the scheme such that the non-inclusion of the sum of $118,128,953 net capital gain as its assessable income is not a tax benefit of which Part IVA applies. 83 Section 177C(2A)(a) operates, relevantly, only where the non-inclusion of an amount of assessable income is attributable to the making of a choice under subdivision 126-B and the scheme consists solely of the making of that choice (or election). The Taxpayer contends that the purpose of the provision is not to exclude from the exception provided for in s 177C(2A)(a) a capital gain not included in a taxpayer's income by reason of the capital gain being rolled over to another taxpayer in the same group. It says that the mischief to which the provision was directed was something completely different, being the multiplication of capital losses so that they exceed in magnitude the underlying economic loss. The Taxpayer contends, in effect, that the word scheme where it appears in different parts of s 177C(2A)(a) is to be given different meanings. It says that there is no such thing as a CGT rollover divorced from a CGT event and that, therefore, s 177C(2A)(a) can have no application if scheme is given the meaning defined in s 177C(1)(a). 84 As I have indicated above, subdivision 126-B speaks in terms of a trigger event involving an originating company and a recipient company. In the present context, that would cover the disposal (trigger event) by the Taxpayer (the originating company) to Rothmans (the recipient company). The language of s 177C(2A) encompasses both a scheme consisting of each of the originating company and the recipient company not making a choice under subdivision 126-B and a scheme consisting of each of the originating company and the recipient company making a choice under subdivision 126-B. Without more, either would satisfy the requirements of s 177C(2A)(a). 85 A scheme could consist of the making of the choice under s 126-55 by the originating company (the Taxpayer in this case) and the recipient company (Rothmans in this case). The tax benefit would be attributable to the making of the choice by the originating company (the Taxpayer) and the recipient company (Rothmans). The steps that will bear upon the decision to make the choice or not to make the choice by both the originating company and the recipient company might commence before, at the same time as, or subsequent to, the happening of the relevant CGT event (the disposal of the 9 Wills Brands in this case). Where the steps commence subsequent to the relevant CGT event, the relevant CGT event may merely be context in relation to the making of the choice by the originating company and the recipient company, rather than being part of the scheme. 86 In the present case, the planning for and implementation of the scheme identified by the Commissioner and described above, in relation to the making of the choice by the Taxpayer and Rothmans commenced many months before the actual disposal by the Taxpayer of the 9 Wills Brands to Rothmans on 3 September 1999 and continued for some time after that disposal. Thus, the scheme consisted of much more than the mere making of the rollover choice or election. Section 177C(2A)(a) was not satisfied in the present case.

Dominant Purpose 87 The Taxpayer contends that the dominant or ruling or prevailing purpose of the Taxpayer, Rothmans and all other parties involved in the scheme identified by the Commissioner and described above was to allow the merger of the BAT Group and the Rothmans Group to proceed both in Australia and worldwide by bringing about the disposal of brands to Imperial and thereby obviating the possibility of intervention by the Commission. The Taxpayer says that the fact that that purpose was effected in a way that utilised capital losses that were properly available to the merged group does not transform that purpose into one of obtaining a tax benefit. 88 The Taxpayer points out that it was only because of the proposed merger of the BAT Group and the Rothmans Group that the Commission intimated that it would intervene. It was to avoid the Commission's intervention that it was necessary to dispose of the 9 Wills Brands to parties outside the merged group. In fact, substantial capital gains were also realised on the disposal by Rothmans to the Imperial Group, of brands that had always been within the Rothmans Holdings group (the Rothmans Brands). For example, there was a $45 million gain attributable to the sale of the Peter Stuyvesant brand by Rothmans to Imperial subsidiaries. Further, the regional organisation resulted in the crystallisation of capital losses on the part of Rothmans Asia and Rothmans Holdings in amounts almost equal to the capital gain attributable to the disposal of the 9 Wills Brands. The Taxpayer contends that, absent the scheme, which includes the disposal of the brands to Imperial by Rothmans, the 9 Wills Brands would not have been disposed of to Imperial subsidiaries and the parties to the merger would have been in breach of the undertaking given to the Commission. Thus, the Taxpayer says, the scheme was an ordinary transaction entered into or carried out for the dominant purpose of successfully completing the merger without intervention from the Commission and therefore does not satisfy Part IVA. 89 However, that analysis ignores the essential concept of the scheme identified by the Commissioner. As I have said, the essential element is to be found in the disposal of the 9 Wills Brands by the Taxpayer to Rothmans and the subsequent disposal by Rothmans to the Imperial Group of the 9 Wills brands, together with the Rothmans Brands. The desired objective of the disposition of all of the relevant brands, both the 9 Wills brands and the Rothmans Brands, to the Imperial subsidiaries could have been achieved by a transfer direct from the Taxpayer to the Imperial subsidiaries of the 9 Wills Brands and a transfer direct from Rothmans to the Imperial subsidiaries of the Rothmans Brands. The requirements of the Commission would have been satisfied and the intended object of the merger would have been achieved. There was no commercial or legal reason why the disposition to the Imperial subsidiaries of both the 9 Wills Brands and the Rothmans Brands should have been effected from a single vendor, transferor or disposer rather than a disposition from separate vendors, transferors or disposers. Precisely the same commercial and legal object could have been achieved without the transfer, sale or disposal by the Taxpayer to Rothmans followed by transfer, sale or disposal by Rothmans to the Imperial subsidiaries. 90 Section 177D(b) points to eight factors to be taken into account in determining whether it would be concluded that the person, or one of the persons, who entered into or carried out the scheme, or any part of the scheme, did so for the purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme. The Taxpayer contends that those factors would lead to the conclusion that the achievement of the merger was the dominant purpose of all persons who entered into or carried out the scheme and that the desire to complete the merger drove both the need to comply with the Commission Undertaking, by divesting of brands to Imperial, and the need to undertake the regional organisation that resulted in the sale of Rothmans Indonesia. The Taxpayer says that the commerciality of the transaction is highlighted when tax is taken into account. Faced with the ability to choose to rollover, it would have been commercially imprudent for the Taxpayer to have chosen to ignore the availability of a rollover and instead elect to pay tax. That contention, of course, begs the question. The question is why it was necessary to create a situation where a choice was possible. 91 The first factor contemplated by s 177D(b) is the manner in which the scheme was entered into or carried out. This factor examines the way in which and the method or procedure by which the scheme was established, entered into and carried out (see Commissioner of Taxation v Spotless Services Limited (1996) 186 CLR 404 at 420). The factor invites consideration of surrounding circumstances. The Taxpayer says that the lack of control that the Taxpayer and other relevant entities had over the disposition of the Australian brands is illustrated by the fact that Imperial could have selected predominantly Rothmans brands. In such a case, there would have been no suggestion of a tax benefit. However, as I have said, once Imperial had chosen the 9 Wills Brands, there is no reason why the Taxpayer could not have transferred or disposed of those brands direct to Imperial or its subsidiaries. 92 The second factor is the form and substance of the scheme. The Taxpayer asserts that the form and substance of the scheme as identified do not diverge. Rather, both are squarely aimed at achieving the merger through the re-organisation of the two groups and the disposal of Australian brands to Imperial. Again, however, the Taxpayer's contentions ignore the basic proposition that the merger and the disposition could have been achieved in a different fashion and there was no commercial imperative that required the disposal of the 9 Wills Brands to Imperial subsidiaries to be effected through Rothmans. 93 The third factor is the time at which the scheme was entered into and the length of the period during which the scheme was carried out. The Taxpayer contends that the timing of the scheme was dictated entirely by the requirements of the global and Australian merger, particularly the timing of regulatory, shareholder and court approvals. It says that the timing and duration point towards the purpose of achieving the merger. That must be so in so far as the object of disposition to Imperial was to facilitate the merger. However, the timing of the disposition by the Taxpayer to Rothmans was critical to achieving the tax benefit. 94 The fourth factor is the result in relation to the operation of the 1936 Act that, but for Part IVA, would be achieved by the scheme. The result achieved by the scheme was to enable the Taxpayer to dispose of the 9 Wills Brands without incurring capital gains tax, by making the rollover choice under subdivision 126-B, after the merger. But for the operation of Part IVA, that result would have been achieved. That points to a conclusion that the scheme was entered into and carried out for the purpose of enabling the Taxpayer to obtain that tax benefit. 95 The fifth factor is any change in the financial position of the relevant taxpayer that has resulted from the scheme. Apart from tax consequences, there was no change in the financial position of the Taxpayer except in so far as it received $181,700,000 from Rothmans upon the disposition of the 9 Wills Brands to Rothmans. That was the value of the 9 Wills Brands. However, the Taxpayer avoided liability for capital gains tax because of the rollover choice, something it could not have done without the scheme. 96 The sixth factor is any change in the financial position of any person who has any connection with the relevant taxpayer, being a change that has resulted from the scheme. Rothmans acquired the 9 Wills Brands for a consideration equal to their value and then disposed of the 9 Australian Wills brands for a consideration equal to their value. There was no change except to the extent that it was able to participate in the use of the tax losses of the Rothmans Holdings group. 97 The seventh factor is any other consequence for the relevant taxpayer or for any person who has any connection with the relevant taxpayer, of the scheme having been entered into or carried out. The consequence for the Taxpayer and the Rothmans Holdings group, as just indicated, was that tax losses were utilised that would not have been utilised by the Taxpayer if the Taxpayer had transferred or disposed of the 9 Nine Wills Brands direct to the Imperial subsidiaries rather than to Rothmans. 98 The eighth and final factor is the nature of any connection between the relevant taxpayer and any person who has any connection with the relevant taxpayer. At the time of the disposition by the Taxpayer to Rothmans, they were both members of the merged group. Prior to that, they were competitors. The relationship enabled the object of the scheme to be achieved, namely the utilisation of tax losses in connection with the disposition by the Taxpayer of the 9 Wills Brands. 99 I consider that, overall, the eight factors required to be considered point strongly to the conclusion that the Taxpayer and Rothmans, both of whom entered into and carried out the scheme, together with other parties, did so for the purpose of enabling the Taxpayer to obtain the tax benefit resulting from the rollover choice. That had the consequence that the Taxpayer was not required to bring into account as assessable income the capital gain of $118,128,953 derived on the disposition of the 9 Wills Brands that would have been derived, without the benefit of set off against tax losses, had they been disposed of direct to the Imperial subsidiaries rather than to Rothmans.

PENALTY 100 As indicated above, there are two issues in relation to the question of penalty tax. I shall deal with each separately.

What the Taxpayer Told the Commissioner 101 The Commissioner places considerable emphasis on the memoranda of 20 May 1999. He also attaches significance to the evidence given by Mr Hardman as to his reasons for agreeing with the proposal advanced by Mr Kingsley. Specifically, the Commissioner says that the subject matter of the memoranda of 20 May 1999 and Mr Hardman's reasons constitute the very matter because of which the provisions of s 226 of the 1936 Act apply. The Commissioner contends that at no time did the Taxpayer tell the Commissioner in writing about that matter. 102 The Taxpayer did not tell the Commissioner in writing that a significant reason for transferring the 9 Wills Brands to Rothmans before they were transferred to the members of the Imperial Group was to enable the merged group to avail itself of the losses available in the Rothmans Holdings group, which would not have been available had there been a transfer direct to the members of the Imperial Group. That is at variance from the assertions made by the Taxpayer in the annexure to Mr Dunkley's letter of 23 September 2002, purporting to advance reasons for the transfer by the Taxpayer to Rothmans. That is a critical step in the scheme identified by the Commissioner, which was not the subject of any written disclosure to the Commissioner prior to the commencement of the tax audit. 103 Accordingly, I would be disposed to accept the Commissioner's contentions that the Taxpayer did not tell the Commissioner, within the meaning of s 226E, about the matter because of which s 226 applies to impose the penalty. It would follow that s 226E does not apply to reduce the penalty.

Did the Taxpayer Tell the Commissioner Voluntarily? 104 The Commissioner contends, however, that, even if the communications from the Taxpayer to the Commissioner did entail telling the Commissioner about the relevant matter within the meaning of s 226E, the Taxpayer did not tell the Commissioner voluntarily within the meaning of s 226E. That is to say, the Taxpayer did not volunteer the information. Rather, it was provided on behalf of the Taxpayer only after the Commissioner requested that it be provided. 105 The Taxpayer contends, on the other hand, that s 226E contemplates only that the Commissioner be told about the relevant matter without resort to legal compulsion. In the present case, the Commissioner did not resort to ss 263 and 264 of the 1936 Act to compel the Taxpayer to provide the relevant information. Accordingly, it is correct to say that the information was not provided under any legal compulsion. 106 I consider that at least three levels can be identified in this context. The first is legal compulsion. Certainly, the Taxpayer provided the information voluntarily, in the sense that it was not compelled to do so. However, the word voluntarily has at least two senses. In one sense, action might be said to be undertaken voluntarily if it is undertaken of one's own free will or accord, without compulsion, constraint or undue influence by others. However, in another sense, conduct may not be said to be undertaken voluntarily unless it is undertaken spontaneously. Thus, voluntary conduct might be action performed or done of one's own free will, impulse or choice, not constrained, prompted or suggested by another. In that sense, one might ordinarily speak of volunteering information in the sense of communicating information on one's own initiative without prompting. The Commissioner contends for that second meaning of the word voluntarily. That is to say, the Commissioner says that s 226E requires that the Taxpayer tell the Commissioner about the relevant matter, on its own initiative, without being prompted or asked. 107 Section 226E, together with s 226D, was inserted into Part VII of the 1936 Act on the enactment of the Taxation Laws Amendment (Self Assessment) Act 1992 (Cth) (the Self Assessment Amendment). The purpose of ss 226E and 226D, in giving a reduction in the penalty otherwise attracted, was to encourage the making of voluntary disclosure by taxpayers. The encouragement of voluntary disclosure is in contrast to the rewarding of a taxpayer who, hoping to avoid detection, defers making disclosure until such time as it becomes obvious that activity of the Commissioner is about to uncover relevant facts. A taxpayer who makes disclosure without being prompted by direct action from the Commissioner receives a substantially greater reduction in penalty than does a taxpayer who defers making disclosure or refrains making disclosure until after being notified of an audit. Section 226E is not intended to extend to every taxpayer who does something other than under compulsion. It applies only to a taxpayer who does something of his, her or its own initiative, without prompting or apprehended pressure from the Commissioner. 108 That is consistent with the object of the regime introduced by the Self Assessment Amendment. I do not consider that s 226E has been attracted in the present case.

CONCLUSION 109 It follows from the above that the Taxpayer's appeal should be dismissed. The Taxpayer should pay the Commissioner's costs of the proceeding. I certify that the preceding one hundred and nine (109) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Emmett.

Counsel for the Applicant: Mr TF Bathurst QC and Mr A Robertson SC with Mr AJ Payne SC and Ms CA Burnett

Counsel for the Respondent: Mr BJ Sullivan SC and Mr JH Momsen

Solicitor for the Respondent: Australian Government Solicitor