[14] In addition, Finance entered into interest rate and currency exchange swaps with third party financial institutions to limit exposure to risks of fluctuations over the short and long term. Samples of some of the agreements entered into by, and information memoranda issued by, Finance were tendered in evidence. In respect of each loan agreement in evidence, Finance was the borrower with its obligations guaranteed by BHPB. It was also the issuer of the information memoranda (guaranteed by BHPB) and it was the contracting party to the Master Swap agreements (with the obligations guaranteed by BHPB).
[15] During the 1990's, Finance's board comprised senior executives from the BHPB Group. By way of example, from 1996 to 1999, Mr GW McGregor, the Executive General Manager Finance for the BHPB Group, was also a director of both BHPB and Finance.
[16] Finance did not have its own staff. It utilised the services of BHPB for which it paid management fees. The fees reflected the proportion of time BHPB personnel spent in providing services to Finance. In the case of Finance, most of the services provided by BHPB were accounting and treasury personnel.
[17] The BHPB treasury personnel had responsibility for determining the cash flow requirements of the BHPB Group using data provided by the operating divisions and relevant corporate staff, arranging the funding of those requirements and determining the form in which the funds would be raised. Performance of those tasks was subject to "Treasury Guidelines" prepared annually by the Treasurer & Vice President Corporate Finance which were then reviewed by the Chief Financial Officer and ultimately approved by the BHPB board. The guidelines provided a series of rules and protocols for a wide range of matters including credit limits (the total amount that could be borrowed from third parties), foreign exchange risk management, guarantees, interest rate and currency swaps, loan facilities and money market activities.
[18] The cash flow requirements of the BHPB Group were assessed on an annual basis through the preparation of annual rolling budgets. Each business unit prepared a budget. Those budgets were then aggregated to form the BHPB Group budget which was ultimately approved by the BHPB board. Preparation of the BHPB Group budget commenced in the March preceding the commencement of the next financial year. The budget forecasts (cash inflows and cash outflows) were prepared for five years on a rolling basis. The forecasts took into account "operating revenues, new (and yet to be approved) capital investments, capital expenditure sustaining existing projects, exploration expenditure and operating costs". Once the budget was approved by the BHPB board, the budget necessarily identified the cash flow shortfall.
[19] The manner in which the shortfall was funded was determined by the Corporate General Manager Taxation, the Corporate Treasurer and, ultimately, the Corporate General Manager Accounting. During the relevant period, the policy was recorded in Section 21.19 of the BHPB Accounting Policy Manual as at May 1996 entitled "Funding of Group Companies" in the following terms:
Details of proposed equity and / or debt funding of new group companies, or of revised funding structures for existing group companies, should initially be provided to the Corporate General Manager Accounting.
Proposals will be passed on to the Corporate General Manager Taxation and to the Corporate Treasurer for review.
The Corporate General Manager Accounting will provide Business Groups with a written "sign off" once the Corporate General Manager Taxation and the Corporate Treasurer have indicated that the proposed funding structure is acceptable. The proposed funding structure should only be put in place upon receipt of this "sign off".
Continuous Review
Capital funding structures of controlled entities should be reviewed regularly to ensure that the structure remains appropriate to the entities' operational and financial standing.
For example, the 100% debt funding of an existing company's activities, other than on a temporary basis, is generally considered to be inappropriate. Similarly a company with high debt and little equity may need to have its structure reviewed if the consequential interest burden is leading the company into negative shareholder funds.
Reviews of company funding structures must be done in collaboration with the responsible taxation officer.
[20] Before turning to consider the projects the subject of dispute in these proceedings, other aspects of the funding of group companies should be noted. First, most BHPB Group companies with bank accounts in Australian currency were part of an ANZ (AFT) sweep facility arranged through Finance. At the end of each day, each account balance was automatically transferred to a single bank account held by Finance. A similar arrangement was set up between Finance and Chase Manhattan Bank for BHPB Group companies with bank accounts maintained in US dollars. A positive bank account of a BHPB Group subsidiary swept to Finance resulted in a credit to the subsidiary's loan account with Finance and each negative balance swept to Finance resulted in a debit to the subsidiary's deposit account with Finance. Any surplus cash would then be placed by Finance on the overnight money market with third party financial institutions.
[21] Secondly, as a result of the process of capital expenditure approval, selection of appropriate funding structures and the banking arrangements referred to in these reasons for decision, the value of loans made by Finance to BHPB Group companies totalled billions of dollars. For example, in the 1995 and 1996 years of income, Finance made loans to the entities listed in Schedule A totalling in excess of $17 billion. Finance had standard lending terms for the inter-company loans which, for the relevant period, were adopted by resolution of the board of Finance on 30 November 1994. Those terms provided:
… intercompany loans granted by [Finance] to [BHPB] or its subsidiaries (together the "[BHPB] Group") from 1 December 1994 will, unless special terms are negotiated for a particular loan, be subject to the following conditions:
a) The interest rate will be 10.45% per annum or such other rate as may be nominated in advance from time to time by [Finance] as the relevant [BHPB] Group intercompany loan rate. Such interest shall be due and payable within 21 (twenty-one) days of the day on which the relevant outstanding loan is repaid.
b) Loans are to be made up of such amounts and are to be advanced on such dates as are agreed orally from time to time by the borrower and [Finance]. Each initial loan and each additional loan is to be for a period not exceeding five months at which time all loans shall become immediately repayable.
c) The currency of each loan will be Australian Dollars.
d) The application of the loan funds will be to fund normal operating activities including research and development where applicable, of the borrower.
e) Commitment fees will not apply.
f) Unless otherwise designated, any repayments shall be applied to reduce the earliest outstanding advance and then be applied first against individual loans in excess of $50,000.
g) For administrative convenience, each loan made by [Finance] under this arrangement will be entered into the one loan account. However it is acknowledged that each amount advanced is a separate loan.
h) [Finance] will consider renewing loans at the close of each five month period should the borrower advise (orally) that it wishes to do so.
[22] One relevant change to these terms and conditions was an adjustment to the inter-company interest rate on 3 March 1995 as a result of a review undertaken by officers from the departments of Corporate General Manager Taxation and Manager Corporate Accounting. After that review, the Corporate Treasurer recommended the following rates apply:
Australian Dollars
11.40% on funds advanced by [Finance]
7.40% on funds borrowed by [Finance]
Where interest payments/receipts are made/received sixty (60) days in advance, the following rates apply:
11.20% on funds advanced by [Finance]
7.20% on funds borrowed by [Finance]
…
Would you please ensure that all subsidiaries are advised of these rates.
[23] As a result of the standard loan terms and in particular cll (b) and (h) of those loan terms (see [21] above), each loan from Finance to a BHPB Group member (including BHPDRI and BHPTM the subject of dispute in these proceedings) was for a five (5) month term.
[24] It is not in dispute that the interest rate charged on loans from Finance to BHPB Group companies was higher than the interest rate at which it borrowed those funds from external third parties and from other members of the BHPB Group. Interest derived by Finance on the loans made to BHPB Group members accrued on a daily basis and was returned as assessable income on an accruals basis in Finance's income tax returns. As a result of the activities of Finance, it earned substantial interest income generating substantial accounting profits after tax and taxable income. The gross interest income, the accounting profits (after tax) and the taxable income of Finance from 1986 to 2002 (before rebates and deductions for tax losses carried forward by or transferred to Finance) was as follows:
Year Interest Income Accounting Taxable
$AUD Profit After Tax Income
1986 1,409,469,373 90,229,086 114,154,910
1987 1,794,112,745 45,731,000 145,313,519
1988 1,260,286,254 536,068,290 76,965,039
1989 1,644,366,392 73,856,000 447,133,044
1990 2,123,000,365 453,106,000 148,808,478
1991 2,087,256,717 238,153,000 405,246,887
1992 1,513,908,695 44,180,632 169,544,782
1993 1,321,699,224 15,031,321 41,524,496
1994 1,005,508,556 231,322,166 (23,127,060)
1995 1,307,201,673 (276,567,336) 44,058,249
1996 2,131,370,433 480,571,938 531,718,141
1997 2,416,871,606 210,122,000 557,555,284
1998 2,171,794,804 (369,118,000) 422,385,267
1999 2,385,768,312 688,988,000 533,496,381
2000 2,935,745,157 (1,321,184,222) (1,659,815,608)
2001 3,305,477,562 80,730,978 776,410,060
2002 3,178,358,105 1,581,916,863 1,679,638,947
TOTAL $34,042,195,973 $2,803,137,716 $4,411,010,816