Commissioner of Taxation v BHP Billiton Limited

Commissioner of Taxation v BHP Billiton Limited - [2011] HCA 17 - HCA 2011 case summary — Zoe

[17]

On 29 June 1995, the BHPB board approved capital expenditure of $1,550 million for the design, construction and commissioning of an iron briquette processing plant and associated facilities for converting iron ore fines into briquettes at Boodarie near Port Hedland in Western Australia. Iron ore fines are of little, if any, economic value and are an impediment to the extraction and sale of ore because of the need to store the fines. Apart from enabling more lump ore to be extracted, the conversion of iron ore fines to briquettes would satisfy obligations of BHPB to the government of Western Australia to carry out secondary processing of iron ore.
BHPDRI was to be the project entity which owned the plant and associated facilities and was to be funded 50 per cent through a subscription of equity from Holdings and 50 per cent through borrowing from Finance. In October 1995 and May 1996, Holdings respectively subscribed for 35 million and 75 million $1 shares in BHPDRI.
At all relevant times, Finance was the principal financier to the BHPB Group and Finance borrowed funds from numerous financial institutions and issued promissory notes and commercial paper to raise short to medium term finance for lending to companies within the Group.
It was not in dispute before the primary judge (Gordon J) that the BHPDRI debt in respect of the project was provided by a loan facility from Finance using Finance's standard lending terms for loans within the Group, which included the payment of interest at a rate higher than the rate at which Finance borrowed funds.
The loan was for a standard term of five months but in practice at the expiry date of each five month period the loan was rolled over by Finance, which involved Finance recording the repayment of the loan in one account, together with recording a fresh loan in another account. In the event of a default in payment of the debt or interest, Finance enjoyed all the rights of an unsecured creditor. The first advance under the facility was made on 31 July 1995. The primary judge found that Finance made the loan to BHPDRI in the expectation that the loan would be repaid in full with interest.
As matters transpired, the cost of the project exceeded the amount of capital expenditure which had been initially approved. Additional capital expenditure of $123.6 million was approved by the BHPB board in November 1996 to be funded 50 per cent through further subscription of equity by Holdings and 50 per cent through further borrowing from Finance. On 30 January 1997, Holdings subscribed for 370 million $1 shares in BHPDRI.
The project experienced technical difficulties and a further review of the project, which commenced in August 1997, recommended further capital expenditure of BHPDRI of $730 million to complete the project, to be funded predominantly by further borrowing from Finance.
In March 2000, the BHPB board approved further capital expenditure by BHPDRI of $46 million and resolved that further review of the investment should occur in September 2000.
Also in March 2000, the Finance board resolved to engage Ernst & Young as independent experts to report on the carrying value of the BHPDRI. Pending the Ernst & Young report, Finance made a doubtful debt provision in respect of the BHPDRI loan which was then approximately $2,174 million, which left Finance with negative net assets in excess of $940 million. A week later BHPB arranged for an injection of equity into Finance of $950 million.
In May 2000, Ernst & Young delivered its report valuing the BHPDRI loan at $346 million. In response, at a meeting held on 3 May 2000, the directors of Finance resolved to treat the balance of the loan, $1,845,833,281, as irrecoverable and bad and directed that it be written off as bad. On 10 May 2000, Finance advised BHPDRI of the write-off of the loan.
Between the period ending 31 May 1996 and the period ending 31 May 2000, BHPDRI made repayments to Finance. There was evidence at the trial in respect of the amount of total advances, accrued interest and repayments as set out in the table below: Year Total Advances Interest Repayments

[37]

The primary judge found that limited recourse debt was not used wholly or partly to finance or refinance BHPDRI's expenditure and accordingly Div 243 had no application to BHPDRI's debt with Finance.
During the course of determining several issues before her, the primary judge found that Finance's lending accorded with the description of the essential business of a finance company in Avco Financial Services Ltd v Federal Commissioner of Taxation[15]. Her Honour found that Finance was not a sham or a mere conduit for its parent but was in the business of lending money for profit making[16].
Her Honour noted that each decision to invest or reinvest in the BHPDRI project was taken on the basis that there would be a return on the project. Initially a payback period of five years from the project's completion was expected[17], although this was adjusted in 1997 to an expectation of a payback period of six to seven years[18]. Further, her Honour characterised the decisions made throughout the life of the project as "a series of reasonable and diligent decisions" made "on the basis of obtaining the best possible return in circumstances that were not ideal"[19]. It must be accepted that her Honour's observation was not confined to Finance.
When her Honour came to consider the application of s 243‑20(1), she rejected the Commissioner's argument that Finance's practical rights of recovery or recourse against BHPDRI were wholly or at least predominantly limited to BHPDRI's assets at the plant at Boodarie[20].
In dealing with submissions concerning s 243-20(2) the primary judge said that s 243-20(2) did not adopt or incorporate a test of economic equivalence, which she regarded as "the substance if not the form of the Commissioner's submissions"[21] in relation to that provision. Her Honour regarded the interaction between Div 245 in Sched 2C of the 1936 Act and Div 243 of the Act as supporting her Honour's rejection of the economic equivalence argument[22].
Her Honour made orders allowing the appeals from the Commissioner's disallowance of objections.

[40]

In this Court, the Commissioner contended that s 243-20(2) is concerned neither with current contractual limitations or rights, nor with economic equivalence, but rather with "a practical capacity or ability to bring about legal limitations on legal rights" irrespective of whether there is any arrangement to which the debtor is a party (s 243‑20(2)(b)).
The Commissioner contended that the expression "capable of", as used in relation to rights in s 243-20(2), means "susceptible to"[28]. That construction was said to encompass "the possibility of contractual variation" between the creditor and the debtor. In urging that construction, and in recognising that any contract may be subsequently varied, the Commissioner sought to distinguish between a legal right which was "theoretically capable" of being varied and one which was "practically or commercially susceptible" to being varied. It was urged that the word "capable" in s 243-20(2) evoked "practical and commercial considerations rather than highly refined legalistic tests" or theoretical considerations. That submission had its source in Canwest Global Communications Corporation v Australian Broadcasting Authority[29], a case concerning a question of control of television licences, in which the tax cases referred to below[30] were distinguished.
Thus, so the argument went, where a creditor's rights were, in practice, susceptible to being altered, so as to introduce a legal limitation on the rights of the creditor against the debtor in the event of default, then the debtor "has not been fully at risk in relation to the amount of the expenditure" funded by the debt.
The respondents contended that the "capacity" to which s 243‑20(2) must refer is a capacity existing at the time of the inception of the loan to bring about legal limitations on contractual rights in the future. It was submitted that the expression "capable of being limited" is not qualified to mean capable of being "practically limited" but must refer to a capacity for limitation as a present attribute (that is, at the time of borrowing), rather than the mere possibility that the attribute might exist in the future. The respondents' contention - that a practical susceptibility to being altered was not what was covered by the expression "capable of being limited" - had the result that the respondents characterised as speculative the Commissioner's contention that such a susceptibility meant that the debtor had not been fully at risk in relation to expenditure funded by the debt.
A consideration of context in the widest sense[31] helps to establish the meaning and reach of s 243‑20(2) and the particular statement that a creditor's rights are "capable of being limited". One wide contextual consideration is that Div 243 of the Act can be expected to operate harmoniously with any applicable companies legislation regulating the conduct of corporate taxpayers. It is also appropriate to recognise that, as well as containing Div 243, the Act makes specific and detailed provisions in respect of bad debt deductions[32] and the 1936 Act dealt specifically with commercial debt forgiveness[33]. Even accepting some overlap between the Divisions, a loan which fell within Div 243 at the relevant time must be capable of being distinguished from a loan which fell within Div 245 as it then stood.
The mischief to which Div 243 was directed, described in s 243‑10, is that a taxpayer may obtain deductions greater than the total amounts outlaid in relation to capital expenditure. In the Explanatory Memorandum to the Bill which introduced the provision, an example[34] is given of the mischief as occurring "where the balance of an outstanding debt that has financed the expenditure is not paid and the financier can only recover a specific asset on the termination of the financial arrangement." Then it is stated[35]:

[44]

In Sidney Williams, Dixon CJ, Kitto and Taylor JJ stated[44] that if persons "may obtain in the future" an ability to control the company, all that can be said of the company as at the last day of the year of income is "that it is capable of being thereafter made controllable by those persons."
Keighery's case and Sidney Williams were relied upon by a Full Court of the Supreme Court of Victoria (Murphy, Fullagar and Gobbo JJ) in Equiticorp Industries Ltd v ACI International Ltd[45] to support the proposition that "when one speaks of a company capable of being controlled in terms of voting power … one looks for an enforceable and presently and immediately existing right enabling the voting power to be controlled."
To describe a creditor's rights of recourse as "capable of being limited" is to refer to a power of a person to limit or bring about a limitation on those rights. In possible deference to the definition of "arrangement" in the Act[46], it was accepted by the respondents in argument that s 243‑20(2) is not necessarily confined to enforceable arrangements; however, this case does not call for any decision about an unenforceable arrangement. It is the certain liability of the creditor's rights of recourse to limitation - by the exercise by a person of a power to limit, or to cause a limitation to those rights - which has the effect that a debtor has not been fully at risk in relation to an amount of expenditure. Such a power must exist at the inception of the loan, whether it arises as a result of an arrangement or a circumstance or conduct (from which an arrangement may be inferred[47]) or in some way other than the way covered by sub‑s (1). It follows that s 243‑20(2) would not be satisfied by the existence, at the inception of the loan, of a possibility of a person acquiring a capacity (that is a power) to limit, or a power to cause the relevant limitation of, a creditor's rights of recourse at some point in the future.
Otherwise it would seem that all loans used by a debtor to acquire property, including loans for special purpose projects involving a corporate group and intra‑group financing, must be characterised as giving rise to obligations which must be treated as limited recourse debts within s 243‑20(2), even though the provision is directed at a debtor taxpayer who has not been fully at risk in relation to an amount of expenditure. Such an interpretation carries the potential, recognised by Edmonds J, for discouraging investment in special purpose projects.
The interpretation of s 243‑20(2) set out in these reasons aligns closely with the language of the Act, which supports the clear legislative purpose[48] of allowing an adjustment of a taxpayer's income if the taxpayer has not been fully at risk in respect of an amount of expenditure. Secondly, the interpretation gives a clear operation to s 243‑20(2) and excludes a conjectural approach to the question of whether an adjustment should be made to a taxpayer's income. This fits with the character of the provision as one which affects liability to taxation. Thirdly, this construction facilitates obedience in circumstances where, despite overlap, a debtor taxpayer wishes to determine whether a debt is capable of being dealt with as a commercial debt which has been forgiven or whether it should be dealt with as a limited recourse debt.

[45]

Whether or not a debt falls within s 243‑20(2) is to be determined by the factual exercise there set out. The Commissioner applied his construction of s 243‑20(2) to underpin a submission that, having regard to the four factors made relevant by pars (a) to (d) inclusive of s 243-20(2), it is reasonable to conclude that Finance's contractual rights against BHPDRI, in the event of default, were capable of being restricted - at the instance of BHPB - to rights against the debt property of BHPDRI.
The Commissioner did not rely on par (b). In essence, the Commissioner's argument in respect of pars (a) and (c) was that the extent of Finance's ability to recover its loan was substantially limited to BHPDRI's plant; that, therefore, there was "no economic disincentive" to Finance accepting a contractual variation formulating the limitation; and that it was therefore reasonable to conclude that there was a capacity in BHPB to procure Finance's acquiescence in a modification of its contractual right so as to confine Finance's recourse to property comprising the plant.
The respondents relied on extensive assets of BHPDRI in evidence before the primary judge including general purposes leases and intellectual property and her Honour's conclusion[49] that "[i]t was by no means clear that all of [BHPDRI's] property was located at or connected with the plant at Boodarie." It was not contested that all of BHPDRI's assets remained available at all relevant times for the purpose of discharging the debt. Finance's status of unsecured creditor gave it no right to any particular asset belonging to BHPDRI, such as the plant[50].
In relation to par (d) it was contended by the Commissioner that the relationship between BHPDRI and Finance was not at arm's length. It was asserted that Finance's conduct in postponing repayment of the loan for a period of 12 months (which was in place at the time of the November rollover) and in not seeking repayment, and Finance's notification to BHPDRI that it would not seek recovery of the amount reported to be irrecoverable, evidenced the fact that Finance and BHPDRI were not dealing at arm's length in relation to the loans.
The respondents submitted that the question as to whether or not BHPDRI and Finance dealt with each other at arm's length is posed in relation to the debt and that the unchallenged findings of the primary judge supported the conclusion that Finance and BHPDRI dealt with each other at arm's length. That argument reflected a distinction relevant to related party transactions, recognised by Habersberger J in Orrong Strategies Pty Ltd v Village Roadshow Ltd[51], between parties being at arm's length and parties dealing with each other at arm's length. Paragraph (d) of s 243‑20(2) expressly refers to a "dealing"[52]. Something more will be said shortly about the relationship between the parties to the loan and the parent company, BHPB.

[46]

Reliance was also placed by the Commissioner on what was described as the BHPB Group's modus operandi under which difficulties in respect of intra‑group obligations were resolved.
In Walker v Wimborne[53], Mason J referred to the principle that each company within a corporate group is "a separate and independent legal entity" with duties imposed by the applicable companies legislation. That this is so was reaffirmed more recently by this Court in NEAT Domestic Trading Pty Ltd v AWB Ltd[54]. In a joint judgment, McHugh, Hayne and Callinan JJ recognised that a wholly‑owned subsidiary may be required to pursue the interests of its parent (and its parent's shareholders) to the extent that those obligations are compatible with other obligations of the subsidiary imposed by the applicable companies legislation and applicable judge‑made law[55]. It is not in contest that on 23 March 2000 the directors of the BHPB board approved additional capital expenditure for BHPDRI, but Finance provided no additional funding and Finance took steps already outlined above. Finance had external creditors. As at 30 June 2000, Finance owed approximately $37 billion to third parties. While the primary judge recognised that Finance may have acted in the BHPB Group's interests, as already noted, her Honour went on to find that Finance was not a sham[56]. The Commissioner affirmed in oral argument that he does not allege that Finance is a sham. Rather, the Commissioner submitted that it was sufficient for the purposes of s 243‑20(2) to show that "[t]he corporate mind of Finance, properly exercised, was legitimately able to have Finance give up rights against [BHPDRI] if the giving up of those rights was in the interests of the [BHPB] Group as a whole."
Finally, after a consideration of the factors in pars (a), (c) and (d), it was contended by the Commissioner that the structure and modus operandi of the BHPB Group support the reasonableness of a conclusion that Finance, from the inception of the BHPDRI loans, would have complied with a request or direction from BHPB to accept a contractual limitation on its rights of recourse against BHPDRI in the event of default if it was expedient to do so or if, in BHPB's assessment, it was in the interests of the BHPB Group to do so. That the construction of s 243‑20(2) contended for by the Commissioner will give rise to a conjectural approach to the question of whether a taxpayer's income should be adjusted is exemplified by this submission.
The crucial submission of the respondents on this aspect of the case is that the Commissioner's contention that Finance would have complied with a request or direction from BHPB to modify its contractual rights of recourse so as to confine its recourse to the plant was "unsupported by any evidence and is … entirely speculative". The submission can be assessed in the light of the construction of s 243‑20(2) set out in these reasons.
The Commissioner's case supporting the application of Div 243 to BHPDRI's debt with Finance was consistent with the construction of s 243‑20(2) proposed by him. The Commissioner's identification of a "practical capacity" in BHPB, existing at the inception of the loan, to cause a relevant limitation on Finance's rights of recourse against BHPDRI, by giving a request or direction to Finance so to limit its rights, never rose above being a possibility of what might happen if certain contingencies arose. Because s 243‑20(2) is not directed to possibilities for a limitation of a creditor's rights of recourse which may arise in the future, s 243‑20(2) does not apply to BHPDRI's debt to Finance. That conclusion renders it unnecessary for this Court to resolve the factual contest concerning the factors in pars (a), (c) and (d).

[48]

The appeals should be dismissed with costs.
GUMMOW J. The Court heard together nine appeals from the decision of the Full Court of the Federal Court (Sundberg, Stone and Edmonds JJ)[57], dismissing appeals against the decision of the primary judge (Gordon J)[58]. Her Honour set aside the decisions of the appellant ("the Commissioner") disallowing objections to assessments to income tax. Pursuant to s 14ZZP of the Taxation Administration Act 1953 (Cth) ("the Administration Act"), the primary judge allowed the objections and remitted the matters to the Commissioner to reassess the taxpayers in accordance with law. The objections related to the four consecutive years of income beginning with that ending 30 June 2003.
BHP Billiton Limited ("BHP") is a listed company and its directly or indirectly wholly‑owned subsidiaries include BHP Billiton Finance Limited ("BHP Finance") and BHP Billiton Direct Reduced Iron Pty Ltd ("BHP Reduced Iron"). From 1 July 2002 the companies formed a consolidated group pursuant to s 703‑50 of the Income Tax Assessment Act 1997 (Cth) ("the 1997 Act").
BHP Finance raised for the purposes of the BHP Group large sums by loan facilities in various currencies and by the issue of promissory notes and commercial paper. BHP Finance applied those funds by making loans to other members of the BHP Group on terms which had been adopted by Board resolution on 30 November 1994 and which did not purport to limit the rights of BHP Finance as an unsecured creditor of the borrowers. The Commissioner has expressly disclaimed in this Court any reliance upon the existence of any arrangement, contrary to those terms, to which BHP Finance was a party.
As applied to the borrowings by BHP Reduced Iron from BHP Finance with which this litigation is concerned, the loans were each for a five month term, with interest in Australian dollars at 11.4 per cent reducible to 11.2 per cent for prompt payment. This interest rate was higher than that payable by BHP Finance on its borrowings and BHP Finance earned substantial interest income. This generated substantial accounting profits after tax and taxable income.
The evidence is silent upon these further points, but it may be observed that the third party sources of funds to BHP Finance would have had a strong interest in any purported limitation upon the rights of recovery by BHP Finance of funds it had lent on to members of the BHP Group, and the listing requirements of exchanges upon which BHP was listed may have had a similar significance. Nevertheless, the Commissioner has sought to characterise the relevant dealings by BHP Finance as of a "non‑arm's length nature".
As is more fully explained by the joint reasons[59], the Board of BHP approved the construction of plant and facilities required for the manufacture, near Port Hedland in Western Australia, of iron briquettes using iron ore fines as feedstock ("the Project"). The expenditure to build the plant and associated facilities for the Project was assessed at $1,550 million. BHP Reduced Iron was to undertake the Project. This company was funded partly by share capital and partly by a loan facility provided by BHP Finance on the standard terms referred to above.
The picture this presented is the not unfamiliar one whereby one member of a company group undertakes a particular development project with finance provided by another member of the group.
However, the Project had a particular characteristic, the strong involvement of the State of Western Australia. BHP Reduced Iron was the holder of a combined total of 195 general purpose leases under the Mining Act 1978 (WA) and was party to an agreement with the State made on 16 October 1995 and contained as Sched 1 to the Iron Ore - Direct Reduced Iron (BHP) Agreement Act 1996 (WA). This recites the agreement of the State to assist in the establishment and operation of a direct reduction plant at Port Hedland.
The Project did not prosper. Further capital expenditures had been required to complete the Project, as explained in the joint reasons[60]. The Project was suspended in May 2004 when one employee died in an industrial accident and two others were severely injured. In November 2004, the plant was placed in care and maintenance while a review of options for the future of the Project was determined. Eventually, in May 2005, BHP announced that the Project was to be terminated. There were significant revenue consequences which have given rise to this litigation. The parties agreed before the primary judge that the outcome in the appeals brought by BHP under s 14ZZ(a) of the Administration Act concerning the years 2003 to 2006 would determine the appeals by the subsidiaries which had received transfers of losses from BHP Reduced Iron.
The expenditure of some $2.1 billion which BHP Reduced Iron incurred on the design and construction of the Project gave rise to "capital allowance" deductions as defined in s 995‑1 of the 1997 Act[61]. These deductions were claimed by that company itself for the years 1996‑2002, and by BHP for the years 2003‑2006 in its capacity as "head" company of the tax consolidated BHP group.
The expenditure by BHP Reduced Iron on the Project in part was funded by advances by BHP Finance totalling some $2,657 million. Of those advances, BHP Finance in May 2000 wrote off $1,845 million. The Commissioner then sought to apply Div 243 of the 1997 Act:

[73]

I agree with what is said by his Honour in that passage. I should add that in this Court the Commissioner eschewed any reliance upon the existence of any "arrangement" to which BHP Reduced Iron was a party, so as to attract par (b) of s 243‑20(2).
Section 243‑20(2) uses the phrase "capable of being limited in the way mentioned in subsection (1)", and the phrase is not qualified. It is not to be taken to mean "practically capable", or "able to be affected" in the future. Rather, the question is resolved in the present appeals by asking whether capacity exists at the inception of each loan by having regard to the four factors listed in pars (a) to (d) (excluding par (b), by reason of the Commissioner's disclaimed reliance upon it).
It was submitted by the Commissioner that BHP Finance's contractual rights, at the inception of each loan, were "capable" of restriction should BHP Reduced Iron default by failing to meet its loan and interest repayments to BHP Finance. That was because, the submissions by the Commissioner went, the parties were not dealing at arm's length within the meaning of par (d) of s 243‑20(2), and before the Federal Court it had been left up to the taxpayer to prove the contrary. Implicit in these submissions is the contention that unless the taxpayer establishes that par (d) is not satisfied, it is reasonable to conclude (within the meaning of s 243‑20(2)) that the rights of the creditor are "capable of being limited in the way mentioned in [s 243‑20(1)]".
The propositions that par (d) applied in these appeals should be rejected. That being so it is unnecessary to determine whether, if it had applied, that would have led to the reasonable conclusion that the creditors' rights were capable of being limited within the meaning of s 243‑20(1).
In Nordland Papier AG v Anti‑Dumping Authority[67] Lehane J considered the definition in s 269TAA(1) of the Customs Act 1901 (Cth) for the purposes of the anti‑dumping provisions of that legislation. The sub‑section reads:

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