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[2011] FCAFC 104
Federal Court of Australia (Full Court)
2011-08-22
Mr J, Logan JJ
Original judgment source is linked above.
Counsel for the Appellant: Mr DH Bloom QC with Mr TM Thawley and Ms KJ Deards
Solicitor for the Appellant: Mallesons Stephen Jaques
Counsel for the Respondent: Mr JS Hilton SC with Mr J Hmelnitsky and Mr B Jones
Solicitor for the Respondent: Australian Government Solicitor
RCI Pty Limited v Commissioner of Taxation [2011] FCAFC 104 CORRIGENDUM
Associate: Dated: 24 August 2011 IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY GENERAL DIVISION NSD 1225 of 2010
BETWEEN: RCI PTY LIMITED (ACN 008 408 848) Appellant AND: COMMISSIONER OF TAXATION Respondent
JUDGES: EDMONDS, GILMOUR AND LOGAN JJ DATE OF ORDER: 22 August 2011 WHERE MADE: SYDNEY
THE COURT ORDERS THAT:
BETWEEN: RCI PTY LIMITED (ACN 008 408 848) Appellant AND: COMMISSIONER OF TAXATION Respondent
JUDGES: EDMONDS, GILMOUR AND LOGAN JJ DATE: 22 August 2011 PLACE: SYDNEY
REASONS FOR JUDGMENT THE COURT: Introduction 1 This is an appeal from a judge of this Court dismissing an application by way of appeal against a decision of the respondent ('Commissioner') disallowing an objection against an amended assessment of income tax issued to the appellant ('RCI') for the year of income ended 31 March 1999 (in lieu of 30 June 1999) ('year of income'). The amended assessment was issued by the Commissioner to give effect to his determination made on 16 March 2006 ('the determination') to include in RCI's assessable income for the year of income the sum of $478,237,746 ('the tax benefit') pursuant to Pt IVA of the Income Tax Assessment Act 1936 (Cth) ('1936 Act'). 2 The ultimate issue before the primary judge, as it is on this appeal, was whether the provisions of Pt IVA, specifically s 177F(1)(a), entitle the Commissioner to make the determination, as well as a further determination under s 177F(2), that the tax benefit shall be deemed to be included in the assessable income of RCI as a net capital gain by virtue of s 102-5 of the Income Tax Assessment Act 1997 (Cth) ('1997 Act'). 3 The primary judge was of the view (at [79] of her Honour's reasons) that both schemes identified by the Commissioner - a narrower scheme or, in the alternative, a wider scheme ('the scheme') - see [9] below, were 'schemes' within the definition in s 177A(1). The primary judge was also of the view (at [88] of her Honour's reasons) that RCI had failed to discharge the burden it had of proving that the Commissioner's alternative postulate, or counterfactual as it is sometimes called, was unreasonable and that, in consequence, RCI obtained the tax benefit, or would but for s 177F have obtained the tax benefit, in connection with the scheme. The primary judge was also satisfied that James Hardie Industries Limited ('JHIL'), James Hardie (Holdings) Inc ('JHH(O)') and RCI both directly and through their employees and advisers entered into or carried out the scheme, or part thereof, and, having regard to the eight matters in s 177D(b), did so for the dominant purpose of enabling RCI to obtain the tax benefit. This is the substantive effect of the conclusions at [117] and [121] of her Honour's reasons, although the latter paragraph seems to be infected with syntactical error. In the result, the primary judge held that the Commissioner was entitled to include the tax benefit in RCI's assessable income of the year of income in reliance on the determination and dismissed RCI's application. 4 At the outset, the background context and the critical events giving rise to the ultimate issue for determination should be summarily recorded, if only to assist an understanding of the relevance of considerable evidence to which reference needs to be made and the analysis of that evidence which follows. The trial before the primary judge and the matters agitated on the hearing of the appeal were fact rich and the case turns on the application of established principles of construction, formulated by the High Court in earlier cases, to those facts. This is not to suggest that the task at hand is any easier than it might be where issues of statutory construction are involved; indeed, the task of applying established principles of construction to facts peculiar to a particular case will, in many instances, be more difficult. 5 RCI is, and was at all relevant times, a member of the James Hardie group of companies ('Group') of which JHIL, a company listed on the Australian Stock Exchange, was the ultimate parent company. A diagrammatic representation of the Group as at 31 March 1998 appears in Appendix A to these reasons. 6 On 31 March 1998 JHH(O), a United States ('US') corporation and the holding corporation of the James Hardie United States group of companies ('US group'), paid a dividend of US$318 million out of an asset revaluation reserve, recently created for the purpose, to RCI as the owner of all the shares in JHH(O) ('the transaction'). Payment of the dividend was satisfied by: (1) A money transfer of US$20 million from JHH(O) to RCI (less US withholding tax); (2) in exchange for JHIL crediting RCI's inter-company account with JHIL in the sum of US$298 million, JHH(O) issued a promissory note ('PN1') with a face value of US$307,415,972 payable on 28 September 1998 to JHIL. The transaction was said, by RCI, to be part of a process of repatriation of funds from the then profitable US Group to Australia, where losses had been, and were continuing to be, incurred, so as to take advantage of those losses and preserve a balance sheet asset which recognised the future income tax benefit ('FITB') of those losses. This was, according to RCI, the purpose of the transaction and it should be concluded, having regard to the eight matters in s 177D(b), as being the dominant purpose of those who entered into or carried out the transaction. On the other hand, the transaction was said, by the Commissioner, to be a precursor to the implementation of a reorganisation of the Group, known at various times by various names but ultimately as 'Project Chelsea', which reorganisation had as its overall purpose the movement of companies in the Group, or the assets of companies in the Group, underneath the umbrella of a vehicle, incorporated either in the US or in the Netherlands, but ultimately in the latter, which had its shares, or some of them, listed on the New York Stock Exchange. According to the Commissioner, the purpose of the transaction was to reduce the market value of the shares in JHH(O) in anticipation of their transfer as a step, indeed the first step, in the implementation of Project Chelsea and so reduce the capital gain that would otherwise accrue to RCI on that transfer; and it should be concluded, having regard to the eight matters in s 177D(b), as being the dominant purpose of those who entered into or carried out the transaction. 7 Throughout these reasons we have adopted acronyms and abbreviations to refer to entities or expressions which recur with some frequency. Where possible, we have adopted the same acronyms and abbreviations as the primary judge or as appear in contemporaneous documents that are in evidence. To facilitate a reading of these reasons, we have produced below a table setting out these acronyms and abbreviations and, in the case of entities, their position in the Group at the relevant time. Acronym/Abbreviation Entity/Expression Position in Group 1936 Act Income Tax Assessment Act 1936 (Cth) 1997 Act Income Tax Assessment Act 1997 (Cth) Allens Allen Allen & Hemsley (now known as Allens Arthur Robinson) C&L Coopers & Lybrand Commissioner the respondent, Commissioner of Taxation the determination the determination made by the Commissioner on 16 March 2006 pursuant to s 177F(1)(a) of the 1936 Act FITB future income tax benefit Group the James Hardie group of companies JHFBV James Hardie Finance BV The Dutch finance company formed as part of Project Chelsea JHFL James Hardie Finance Ltd The Australian Group finance company wholly owned by JHIL JHH(I) James Hardie (USA) Inc Wholly owned by JHH(O) JHH(O) James Hardie (Holdings) Inc The US group holding company JHIL James Hardie Industries Limited The ultimate parent company of the Group until October 2001 JHIL Group The Group when JHIL was the ultimate parent company JHINV James Hardie Industries NV The ultimate parent company of the Group from October 2001 JHNV James Hardie NV JHNV group The group proposed to be owned by JHNV Pedley paper the paper identified in [42] below PN1 Promissory note 1: with a face value of US$307,415,972 issued by JHH(O) to JHIL payable on 28 September 1998 PN2 Promissory note 2: with a face value of US$50,229,768, issued by JHIL to RCI on 23 September 1998 PN3 Promissory note 3: with a face value of US$675 million, issued by JHIL to RCI on 2 October 1998 Project Chelsea, Chelsea or the Project (previously known as Project Scully and before that Project X) the names given to the reorganisation of the Group in its various manifestations PwC PricewaterhouseCoopers RCI the appellant, RCI Pty Limited Wholly owned by JHIL RCI Malta RCI Malta Holdings Limited The transferee from RCI of the shares in JHH(O) RCI Malta 2 RCI Malta Investments Limited Wholly owned by RCI Malta the scheme the narrower scheme or the alternative wider scheme identified by the Commissioner: see [9] below the tax benefit $478,237,746 the transaction the dividend of US$318 million paid by JHH(O) to RCI on 31 March 1998 as described in [6] above US United States US group the James Hardie United States group of companies Warburgs SBC Warburg Australia Corporate Finance Limited year of income the year of income ended 31 March 1999 (in lieu of 30 June 1999)
The Determination and its Ingredients - the Commissioner's Position 8 The Commissioner identified the scheme, the counterfactual upon which he calculated the tax benefit and the parties in respect of which he alleged a conclusion under s 177D(b) should be drawn in his Reasons for Decision which accompanied his objection decision (AB 1, 35 - 83). The scheme 9 The Commissioner identified the scheme as a narrower scheme or, in the alternative, a wider scheme. In essence, the narrower scheme was identified as the transaction: see [6] above. The narrower scheme (1) The revaluation by JHH(O) of its shareholding in James Hardie (USA) Inc ('JHH(I)'), resulting in a US$318 million surplus; (2) the resolution by the board of JHH(O) on 30 March 1998 to pay a dividend to RCI of US$318 million; (3) the satisfaction of payment of the dividend to RCI by: (i) JHH(O) paying US$20 million to RCI; (ii) JHIL, at the direction of JHH(O), crediting RCI's inter-company account in the amount of US$298 million in exchange for JHH(O) issuing PN1 to JHIL in the sum of US$307,415,972 payable on 28 September 1998. The wider scheme (1) The narrower scheme, together with the following additional steps; (2) the injection of US$50,229,768 additional equity into JHH(O) by RCI in consideration for the allotment by JHH(O) of 570 additional shares in itself to RCI on 26 August 1998; (This step was not referred to in the identification of the 'wider scheme' in the Commissioner's appeal statement (AB 1, 95 at [50]) but was referred to by the primary judge at [5] of her Honour's reasons.) (3) the transfer by RCI of its shareholding in JHH(O) to RCI Malta Holdings Limited ('RCI Malta') for US$94,290,968 on 15 October 1998 in exchange for 94,290,968 shares in RCI Malta. 10 Both before the primary judge and on the hearing of the appeal, the Commissioner adhered to his identification of the scheme, in particular a narrower scheme of the kind described in [9] above or, in the alternative, a wider scheme of the kind described in [9] above. The counterfactual upon which the tax benefit was calculated 11 As noted in [1] above, the determination identified as the tax benefit the non-inclusion of an amount of A$478,237,746 in the assessable income of RCI for the year of income. This amount was calculated on the basis that, had the scheme not been entered into or carried out, it might reasonably be expected that: (1) a cash dividend of only US$20 million, from revenue profits, would have been declared (those being the available cash reserves of JHH(O) as at 30 March 1998); (2) RCI would not have subscribed for the additional 570 shares in JHH(O) for US$50,229,768; (3) RCI's shares in JHH(O) would have been transferred to RCI Malta for the sum of US$342,061,200 ($539,613,819), being the market value of JHH(O)'s shares of US$94,290,968 (as determined by the directors) plus US$298,000,000, being that part of the US$318 million dividend out of the valuation reserve minus the US$50,229,768 share subscription; and (4) RCI's cost base in the shareholding of JHH(O) would have been $15,404,309. (The capital gain on the Commissioner's counterfactual is $524,209,510 ($539,613,819 less $15,404,309) which is also equal to the sum of the tax benefit ($478,237,746) and the gain returned ($45,971,764) by RCI. Tax on the Commissioner's counterfactual capital gain is $524,209,510 x 36% (corporate tax rate) = $188,715,424. What is said by the primary judge in the third sentence of [6] of her Honour's reasons is incorrect.) 12 Before the primary judge and on the hearing of the appeal, the Commissioner adhered to his identification of the tax benefit obtained by RCI in connection with the scheme on the basis that if the scheme had not been entered into or carried out it might reasonably be expected that a reorganisation of the Group, involving the transfer by RCI of its shares in JHH(O) to RCI Malta in exchange for shares in that company, would nevertheless have proceeded. The identification of the counterfactual and the consequent calculation of the tax benefit, if any, are dealt with at length at [125] to [150] below. The parties which entered into or carried out the scheme 13 The Commissioner identified the parties which entered into or carried out the scheme, or part of it, and in respect of which a conclusion under s 177D(b) should be drawn that they did so for the dominant purpose of enabling RCI to obtain the tax benefit in connection with the scheme, as being 'RCI or another person': AB 1, 81. In his appeal statement, the Commissioner's identification of these parties extended to JHH(O), JHIL, RCI Malta and PwC in addition to RCI: AB 1, 96 at [53]. The matter was not ventilated before the Court on the hearing of the appeal but we note that at [117] of the primary judge's reasons her Honour confined her conclusion as to the parties which entered into or carried out the scheme as being 'JHIL, JHH(O) and RCI both directly and through their employees and advisers'. Having regard to the Commissioner's identification of the scheme, her Honour's confinement of the parties which entered into or carried out the scheme so as to exclude RCI Malta and PwC, is not surprising. PwC the firm, did not exist at the relevant times; neither at the time the scheme was entered into nor at any time over the period that it was carried out. In any event, her Honour's confinement of the parties is unlikely to give rise to any different consequence; it is unlikely that, having regard to the eight matters in s 177D(b), one would come to a different conclusion as to the dominant purpose of RCI Malta or C&L in entering into or carrying out the scheme, than one should reach in respect of JHH(O), JHIL and RCI. The Determination and its Ingredients - RCI's Position The scheme 14 Both before the primary judge and in its written submissions on appeal RCI took the position that the narrower scheme identified by the Commissioner was not a 'scheme' within s 177A(1) to which Pt IVA applies and that the primary judge erred in concluding to the contrary. RCI pointed out that the narrower scheme did not include the transfer of the JHH(O) shares by RCI and it is only the transfer of those shares that could give rise to the tax benefit contended by the Commissioner to have been obtained by RCI in connection with the scheme. This submission was not pressed orally on the hearing of the appeal, correctly in my view. What the primary judge said at [75] of her reasons is a complete answer: 'Attractive as that submission may seem initially, it makes an unwarranted assumption. Section 177D(a) provides that a scheme to which Part IVA applies is, relevantly, one where "a taxpayer … has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme"; [emphasis added]. There is nothing in the provision which says that the tax benefit has to be generated by a step in the scheme.' As the primary judge pointed out at [76] of her reasons, a similar issue arose in Commissioner of Taxation v Consolidated Press Holdings Ltd (2001) 207 CLR 235 where the borrowing by Australian Consolidated Press Ltd ('ACP') of loan funds from Consolidated Press (Finance) Ltd giving rise to interest deductions was not included as part of the narrower scheme identified by the Commissioner, namely, the interposition of Murray Leisure Group Pty Ltd between ACP and two members of the Consolidated Press group incorporated in the United Kingdom, Consolidated Press International Ltd and Consolidated Press International Holdings Ltd. Nevertheless, ACP was held to have obtained a tax benefit in connection with the scheme so identified. 15 In relation to the alternative wider scheme identified by the Commissioner, both before the primary judge and in its written submissions on appeal, RCI took the position that the first three steps, which relate to the payment of the dividend to RCI, did not bear a sufficient relationship to the last step (the transfer of shares) for it to be properly concluded that, for the purpose of Pt IVA, they are part of the one scheme. Again, this submission was not pressed orally on the hearing of the appeal, correctly in my view. The primary judge was of the view (at [69] of her Honour's reasons) that the dividend payment and the share transfer were connected in that examination of the documentary evidence 'supports the view that the dividend [payment was] part of the complex restructure known as Project Chelsea' (at [70]). Whether that be right or wrong, as the primary judge observed at [73], 'the fact that those involved in the dividend planning understood it to have an independent commercial rationale is not inconsistent with it being part of Project Chelsea and thereby being connected to the share transfer from RCI to RCI Malta'. In any event, as Gummow and Hayne JJ said in Commissioner of Taxation v Hart (2004) 217 CLR 216 at [47]: '[T]here is no basis to be found in the words used in Pt IVA for the introduction of some criterion additional to those identified in the Act itself. There is no reference to a scheme having some commercial or other coherence.' (Emphasis added.) On the other hand, as was said in Federal Commissioner of Taxation v Ashwick (Qld) No 127 Pty Ltd [2011] FCAFC 49 at [138] and [143] per Edmonds J (with whom Bennett and Middleton JJ agreed), while a lack of commercial or temporal coherence may not impede a conclusion as to the existence of a scheme, it may, having regard to the criteria in s 177D, impede the drawing of a conclusion that the dominant purpose of a party who/which only enters into or carries out part of the scheme, being a part temporally distinct from another part or other parts of the scheme, was to obtain or enable the relevant taxpayer to obtain a tax benefit in connection with that scheme, and so render Pt IVA inapplicable to the scheme as identified. The counterfactual upon which the tax benefit was calculated 16 From the outset, that is from the time the Commissioner made the determination and his amended assessment to give effect to it, RCI's position has been that if the scheme as identified by the Commissioner had not been entered into or carried out, it would not have, and it could not reasonably be expected to have, embarked on a reorganisation of the Group involving, as Project Chelsea did, the transfer of RCI's shares in JHH(O) to RCI Malta, or any other entity for that matter, at a tax cost of $188 million. At the very least, that part of the reorganisation that was Project Chelsea as involved the transfer of RCI's shares in JHH(O) to RCI Malta would have been indefinitely postponed until other possibilities, which existed and which did not involve such a prohibitive cost for an intra-group transaction, could be explored. As such, there was no tax benefit obtained by RCI in connection with the scheme. So much is recognised in the Commissioner's Reasons for Decision at AB 1, 69. As noted in [12] above, these are matters which are dealt with at length at [125] - [150] below. The parties which entered into or carried out the scheme 17 In its notice of appeal (AB 1, 208 - 210), RCI did not put in issue the primary judge's finding at [117] of her Honour's reasons that it was JHIL, JHH(O) and RCI that entered into or carried out the scheme, only her Honour's further finding in the same paragraph that one or more of them did so for the dominant purpose of enabling RCI to obtain the tax benefit. The Evidence Before the Primary Judge The Witnesses 18 Before the primary judge, the following former JHIL senior executives were called by RCI to give evidence: (1) Donald Alexander John Salter - a financial consultant to the Group. Mr Salter commenced working for the Group in 1975 as a cost accountant in its Brisbane office. He was appointed assistant group tax manager in 1988 responsible for preparing and reviewing the Group's tax returns, and from 1998 reported to the then Group Financial Controller, Mr Stephen Harman. He retired as Tax Manager for the Group in Australia in October 2007 and has been consulting to the Group on an ad hoc basis since then. (2) Phillip Graham Morley - a financial consultant to the Group. Mr Morley was the Chief Financial Officer of JHIL and the Group from March 1997 to May 2004. Prior to that Mr Morley had been the Executive General Manager of the Building Services Division, a major business unit of the Group, since 1 July 1995. In his capacity as Chief Financial Officer, his responsibilities included Treasury accounting, finance (including tax) and internal audit for the Group. (3) Stephen Edward Harman - was Group Financial Controller from September 1997 to January 2002. Prior to that, Mr Harman had been employed at the offices of JHIL in Sydney since 1986, first as Group Financial Systems Manager, then as Group Chief Accountant and finally as Manager, Financial Planning. As Group Financial Controller he reported to the Chief Financial Officer, Mr Morley. From November 1998 Mr Harman was based in California. He left the Group in January 2002 when he was made redundant. 19 RCI also called, Michael Robert Brown, a non-executive director of JHIL from September 1992 to 2001 and of JHINV from 2001 to 20 February 2007. Prior to joining JHIL as a director, Mr Brown had been Finance Director of Esso Australia Limited from 1987 to 1991. After leaving Esso Australia Limited, Mr Brown was Finance Director and Chief Financial Officer of Renison Goldfields Consolidated Limited for three years, Finance Director at Goodman Fielder Wattie Limited for a short time, and subsequently, Group Finance Director and Chief Financial Officer at Brambles Industries Limited from 1995 until 2000. From 1996 Mr Brown was Chairman of the Audit Committee of the Board of directors of JHIL and continued in that role while he was a director of JHINV. (Mr Michael Brown should not be confused with Mr Allan Brown, the Group's treasurer who was not a witness but who was the author of strategy papers exhibited to the affidavit of Mr Morley: see [33] - [35] below.) 20 RCI also called Anthony Edward Clemens, chartered accountant and a partner of PricewaterhouseCoopers ('PwC') in Australia. As at June 2008, Mr Clemens had been a partner of PwC and its predecessor firm, Coopers & Lybrand ('C&L'), for more than 20 years. 21 RCI called Douglas McLelland Edwards, a US lawyer, who had practised law in the US for 31 years, 29 of those in the State of Nevada, as an expert in US corporate and income tax law, to give an opinion on the application of that law to the transaction. 22 All RCI's witnesses were cross-examined. 23 The primary judge found at [9] of her Honour's reasons that the accounts given by the witnesses of the issues they identified as facing the Group in the period with which the proceeding was concerned were largely consistent with each other. Her Honour observed: 'Except where otherwise indicated I have accepted the evidence of the witnesses.' In our view, there is nothing elsewhere in her Honour's reasons to indicate that she did not accept any aspect of the evidence given by any of the witnesses. Senior counsel for the Commissioner sought to take issue with that view pointing first to [27] and then to [70] of the primary judge's reasons. At [27] her Honour said: 'A paper entitled, "Project Scully - US Tax Considerations", was prepared by C&L US (Peter Belanger and Keith Sheppard) in May 1997. It considers the payment by JHH(O) of a stock dividend to RCI. The paper notes that the gain to RCI from the subsequent disposal of JHH(O) to the new holding company would be taxable in Australia but also notes that the stock dividend would have increased RCI's cost base. Despite Mr Morley identifying handwriting on the paper as his, he said he did not consider a stock dividend until January 1998. He said it was not a paper that he "would have provided to, or discussed with, the Board". Irrespective of Mr Morley's recollection of the paper, it must follow from his handwriting on the paper that he was at least aware of the stock dividend proposal at that time.' But senior counsel for the Commissioner conceded, as he had to, that her Honour's conclusion in the last sentence does not necessarily follow from the handwriting present on the document of May 1997. 24 At [70] her Honour said: '[C]lose examination of the documentary evidence which, as the Commissioner submits, is likely to be more reliable than the recollections of persons involved in transactions that took place more than 10 years ago, supports the view that the dividend payments [sic] were part of the complex restructure known as Project Chelsea.' What her Honour said was said in the context of her Honour's consideration of whether the dividend payment (not 'payments') and the share transfer were part of the same scheme. In any event, nothing her Honour said in [70] of her Honour's reasons amounts to rejection of any aspect of the evidence given by any of the witnesses. 25 Apart from tendering certain documents, the Commissioner called no evidence. In particular, the Commissioner called no expert evidence in support of his arguments which underlay the counterfactual upon which the tax benefit was calculated. Background 26 Prior to the early 1990s the Group had primarily derived its revenue from its business of selling building products in Australia. In the late 1980s the Group had acquired a gypsum business in the US and commenced manufacturing and selling fibre cement building materials there. 27 Until around 1995, the Group's operations in the US had been performing poorly and had not been generating profits. This poor performance in the US had given rise to US tax losses which had been accumulating for some time. Under the applicable accounting standards at the time, the US tax losses could only be reflected as an asset in the future income tax benefit ('FITB') balance in the Group's consolidated accounts if it was 'virtually certain' that those losses would be recouped within a three year timeframe. In order to preserve the FITB balance and to obtain an economic benefit from the available US tax losses, interest-bearing deposits were established in subsidiaries of the US group. The interest income derived from these deposits was offset against the US tax losses. 28 By around 1995, the US businesses improved their performance and were generating profits which recouped the US tax losses. At around the same time, the Group's Australian operations were experiencing declining profitability. By 31 March 1996, there were approximately $194 million of Australian carry forward tax losses and a FITB balance of $81 million of which $70 million was attributable to Australian tax losses. The Group had raised debt in Australia to fund the previously unprofitable US operations and this contributed to increased losses in Australia. This created the same problem as that referred to in [27] above in relation to the US, in that it jeopardised the ability of JHIL to satisfy the applicable accounting test that realisation of the benefit of the losses by recoupment had to be virtually certain (within a three year timeframe) before the accumulated tax losses could be recognised as an asset in the form of a FITB. 29 The increasing profitability in the US and the declining profitability in Australia also created a further problem in that it became increasingly difficult for JHIL to pay a franked dividend to its shareholders. The policy of the Group was to pay franked dividends. Not to be able to do so was viewed adversely in the market. To pre-empt this, it was desirable for the Group to pay as much tax as possible in Australia rather than in other jurisdictions. However, the US operations faced the prospect of paying tax which could not be used to frank dividends for Australian tax purposes. Additionally, the US group was subject to a higher effective tax rate than in Australia because profits that were derived in the US were liable to US federal and state corporate taxation in the first instance and further subjected to US dividend withholding tax when remitted to Australia. JHIL's shareholders would then also pay tax in Australia when profits were distributed to them as dividends. In the absence of franking credits, shareholders would bear the burden of being assessable under Australian tax laws for the entire amount of a dividend which had its origins in profits that had already been subject to high effective tax rates in the US. 30 The tax issues confronting the Group and the recognition of accumulated Australian tax losses as a FITB were some of the subjects of a meeting held on 16 August 1995 at the offices of C&L in Sydney at which Messrs Allan Brown, Harman and Salter, amongst others from JHIL, were present and at which Messrs Clemens and Keith Sheppard, amongst others from C&L, were present. Notes of that meeting were prepared by Mr Keith Sheppard on 28 August 1995 and record, inter alia: 'Overall Group Tax Loss Position 4 It was noted that the most recent estimate in relation to Australian tax losses is that, excluding losses from the R&D company, there should be sufficient tax losses to cover profits for the next four years (subject to foreign exchange movements). However, both the US and New Zealand are likely to be in a tax paying position by the end of the 1996 year. 5 Therefore, the main thrust of current tax planning is to borrow externally in New Zealand and the US and repatriate funds to Australia to enable the Australian group to retire existing debt. In addition, loans from Jersey to Australia (via the US) should be reduced. Other parts of the Jersey financing structure must stay in place for the present. 6 Finally, a further aspect of the current tax planning is to shift the recent US dollar borrowing from Australia to the US group. US Repatriation 7 In accordance with the main tax planning referred to above, Stephen Harman outlined current plans for the repatriation of cash funds from the US group to Australia. These plans are somewhat detailed and documented elsewhere…' According to Mr Harman: '[I]t was intended that any repatriated cash in Australia not used to retire debt would be placed on deposit to derive Australian interest income that would be offset against the accumulated Australian tax losses. At the same time, the increased interest deductions in the US would reduce US tax payable.' According to Mr Salter: 'One of the major items of discussion at the meeting as a result of the ongoing profitability of the US operations was the desire of the James Hardie Group to borrow funds in the US and repatriate cash to Australia. This would increase gearing in the US, increase assessable income in Australia and address the Australian FITB problem. I recall discussions to the effect that the repatriation of cash was intended to enable the Australian companies to repay debt and invest surplus cash so as to generate assessable income in Australia. Like in the US before the US operations became profitable, the Australian interest income would absorb the Australian tax losses.' 31 At [12] of the primary judge's reasons, her Honour found that: 'At regular meetings over the next few years "the recognition of Australian tax losses as an FITB continued to be an important issue" as was the balance of franking credits available for distribution to JHIL's shareholders. Various measures were considered as a means of addressing the problems.' 32 Her Honour then said: 'One such proposal mentioned at a meeting on 21 January 1998 was Project Chelsea.' If her Honour was referring to the meeting that took place at C&L, Los Angeles, on 21 January 1998 referred to at [31] of her Honour's reasons, then, with respect, the evidence clearly establishes that Project Chelsea was never mentioned at that meeting. It may be that her Honour was referring to some other meeting that took place in Los Angeles on that day or around that time (see [64] below). Moreover, Project Chelsea was never put forward as a means of addressing the problems of maintaining or preserving FITB balances for accumulated tax losses or franking credit balances for distribution to Australian shareholders. Indeed, in many respects the object of repatriating assets from the US to Australia to generate income in Australia and deductions in the US by measures such as the transaction were at odds with the objects of Project Chelsea. These are matters which are the subject of further analysis below. The Allan Brown Plan 33 Certainly, over the next twelve months these tax and accounting problems did not dissipate or go away. So much is exemplified in two board papers, written in August and September 1996 respectively, by the Group Treasurer, Mr Allan Brown. 34 In the August paper, Mr Brown painted the background problems and the alternatives available to overcome those problems in the following way: 'Background The YEM 96 opening positions for the 3 year tax forecasts in each jurisdiction are shown below: Australia: Australia is in deep tax loss and expected to remain so for some time. Apart from losses associated with restructuring, the Australian entities face a disproportionate interest burden. USA: Approximately US$3 million carry forward loss but substantial tax payments due to start in the current year. Tax payments of US$8.5 million, US$17 million and $27 million are expected for YEM 1997, 1998 and 1999 respectively. New Zealand: A payment of NZ$11 million for YEM 96 is forecast, due to the maturity of a SAFA bond. Payments of NZ$1.5 million in 1996/7, NZ$0.7 million in 1997/8 and NZ$2.5 million for 1998/9 are forecast. … The Australian and USA operations require urgent attention in order to minimise the tax payable in the US and maximise assessable income in Australia. This course of action will be of greater benefit to shareholders than to pay tax in the US and continue with losses in Australia. In addition to the benefit to shareholders, Australian carried forward tax losses have reached a level that now questions the Company's ability to cover these losses from future Australian profits. If the Australian operations are not able to tax effect future losses, the full value of the losses will flow to Operating Profit After Tax. Current Future Income Tax Benefits (FITB) of A$70 million are currently carried in the Balance Sheet. This FITB amount represents carried forward losses of A$194 million. Action was taken last year to reduce the impact of tax on the US and to reduce Australian debt by the repatriation of funds from the US. In addition, US$158 million of debt was transferred from Australia to the US entities. Despite the above action, further funds need to be transferred from the US. Apart from the growth in underlying profits, the US group has funds on deposit of about US$70 million. The funds on deposit will grow to between US$170 and $200 million when proceeds from the sale of Irrigation are received. Alternatives There are limited means of repatriating funds from the US to Australia i.e: Redemption of Capital Payment of a dividend The US group purchases assets for value from the Australian group. … A number of alternatives have been considered and these are dealt with below. The alternatives were assessed with a view to cost and simplicity. James Hardie USA elects to pay a lump sum royalty to Australia. A new royalty agreement is being negotiated with the US. The level of royalty is expected to be approximately 6% of fibre cement sales revenue. Coopers and Lybrand, in the US, have indicated 6% should be an acceptable level of royalty to charge. However, further work is being done to justify the appropriate rate under Transfer Pricing regulations of the US. Formal sign-off from our tax advisers will be a pre-requisite in pursuing this alternative. … A lump sum receipt of a royalty in Australia will be treated as assessable income in the year of receipt. In the US however, no immediate deduction for the payment will be available. The US operations will be able to claim a deduction each year based upon the actual sales for that year, at the royalty rate. If the forecast sales do not eventuate, the Group will have paid tax in Australia but will not receive a full deduction in the US until the actual sales reach the original forecast. If sales in excess of the forecast are achieved, an adjustment to the royal [sic] payment can be made in the future. … James Hardie USA redeems shares held by RCI Corporation, borrows a significant sum and pays a large dividend. This alternative has two elements to it:
... … (Emphasis added.) 48 It is to be noted that the steps in the table above are described as: 'The steps which might be taken to achieve the above'. The last three steps contemplate JHH(O) revaluing its investment in JHH(I); JHH(O) paying a stock dividend to Australia; and RCI contributing JHH(O) to Newco (a new US holding company) 'under a "busted" Section 351 transaction'. The tax implications asserted for these three steps are said to be no US income or withholding tax; increase in basis for US tax purposes; exempt dividend for Australian tax purposes; and increase in basis for Australian tax purposes. 49 In the same month, that is, May 1997, Warburgs made a presentation to the Board of JHIL entitled 'Project Scully'. The presentation included the following topics and items within those topics: 'Key Tax Considerations • No capital gains tax on moving Aust / NZ / Asia into US group • New international group structure creates tax advantages for Newco and CFC income for Scully • Existing tax losses absorbed by selling plant at original cost • Future repatriations - incur 5% withholding tax • Franking credits adversely affected in future by new rules • Stamp duty on transfer of Australian operations Key Legal Considerations • EGM Ordinary resolution for US float and off market share buy back • Asbestos • US Securities Rules Key Commercial Considerations • Key driver is value • JHIL investment story • Market reaction • Completion risk • Takeover threat • Management issues and timing Discussion of Key Issues Advantages • Value creation from arbitrage and improved transparency • geographic alignment of management and investor base with core business is sound • US investors a pure play without negatives of current structure • Shareholders reinvest in US IPO • Optimises gearing • Market timing Disadvantages • US IPO valuation fully valued • Indemnify liabilities • Completion risk • Disclosures • US compliance and disclosures • Takeover risk • Corporate governance • Transaction costs' 50 Following the Board presentation, Dr Keith Barton, the Managing Director of JHIL, and Mr Morley met with the directors of JHIL, other than Mr Pedley, to discuss the Pedley paper proposal. To the best of Mr Morley's recollection, a majority of the Board expressed various reservations about the proposal and, on 18 June 1997, Dr Barton and he prepared a list of the issues raised by the directors. It read as follows: 'PROJECT SCULLY Issues arising from the May, 97 Board Presentation • What alternatives have been considered? We need to look at a couple of scenarios (one of which would be BAU) and evaluate the + & -. There is a view by some Directors that we have simply accepted Pedley's model and worked on that. • They were not comfortable that enough work had been done on USA asbestos. US asbestos advice will need to be firmed up and could change when a prospectus is prepared (McGregor). • They also were uncomfortable about other "spoilers". Asbestos in Australasia, Firmandale - can they be dealt with effectively? (McGregor). Firmandale remains an issue which needs to be resolved (McGregor). • We briefly discussed organisational issues and recognised them as being significant. Willcox made the statement that there couldn't be one CEO for Scully and Newco. • There was some discomfort with the timeframe. It's obviously a big call for the Board and they need time and discussion to get comfortable. • There was a comment re the $4.65 pricing to the effect - "We are at $4.25 now so why bother." Difficult to see how this transaction necessarily adds value, particularly with the high transaction costs (M Brown). • From Mike Brown "The really important question is what will BIL do if we don't go down this path?" • Transaction costs a general issue (Brown, Willcox, Hellicar) • Management post listing an issue (all) - RKB/PGM to revert next meeting • Linked to timing - should we wait until new products are released in USA which would probably add further value (Willcox, McGregor) • Composition of Board post float • 15-20% float about the "right" level (Brown) • Was asked "Where to from here?". I said I thought we needed to get a detailed plan of work to explore those critical issues which needed development before the Board could give an "in principle" go/no go decision. I said we would have this plan for the next Board meeting.' 51 A further meeting of the JHIL Board was held on 1 July 1997. Dr Barton prepared a note of that meeting outlining additional issues raised by the Board concerning Project Scully which were sent to Mr Clemens and Allens by Mr Anthony Sweetman of Warburgs. The note read: 'PROJECT SCULLY Issues arising from the June, 97 Board Presentation • Alternatives: There needs to be more explanation of the alternatives and why they have been discarded. (Meredith Hellicar). • Tax: Need a brief paper describing what the various tax issues are and the respective resolutions. (Mike Brown). • Criteria for Success: Need to be defined and Scully measured against them. (Meredith Hellicar). • Scully (the Rump): This was seen by all to be a major issue. What is the "end game" for Scully (Michael Brown). Peter Pedley said he would have a paper on Scully within 3 weeks (a plan to make Scully bulletproof/self destructing/sharkproof!) • Organisational issues: Willcox referred to the SBCW paper which talked about governance issues and not management issues which he thought were just as important. Peter Pedley keeps referring to a business which "stands on its head rather than its legs". Next discussion will be before the next board meeting in Melbourne. In the meanwhile we should progress all the action items on the SBCW paper and in particular PGM to brief Allens so in turn they can get advice from Shea and Gardner for Skadden, Arps et al. RKB 2 July, 1997' 52 On 16 July 1997 Mr Clemens sent a memorandum to the 'Scully Board' headed 'Taxation Issues' which had been prepared by him and Mr Wybe Mebius, an employee of C&L in the Netherlands, who was on secondment in Sydney at the time. The memorandum commenced: 'Further to the discussion in relation to issues that arose from the May 1997 Board Presentation of Project Scully, this memorandum addresses the principal taxation issues in relation to Project Scully as currently proposed, it analyses which structuring benefits could not be achieved if the Project would not occur and it addresses the tax implications associated with an offer at a retail book build price. Project Scully: taxation issues The taxation issues relating to Project Scully are categorised and dealt with in the following paragraphs: • Shareholders issues: issues associated with the proposed repatriation of cash to current shareholders; • Transactions issues: issues relating to the transactions which need to be effected to implement the proposals; • Ongoing flow of income issues: issues which relate to the ongoing tax efficiency of the reconstructed group.' 53 Under the heading 'Transaction Issues' and sub-heading 'Taxation issues related to sale of US assets', there appears the further sub-heading: 'Step up in basis of the current US group'. The memorandum under that head reads: 'When setting up the US holding company structure, a step up in basis of the US Group currently owned by Australian [sic] could be created, so as to reduce the potential impact of the application of the FIRPTA rules on a future disposal by Australia of any further shares in the US. This could be achieved by implementing the following steps:- (a) The Hungarian company is liquidated. Implementing this step is tax free from an US perspective, whilst rollover relief is available in Australia; (b) RCI contributes Class A shares in JHH(I) to JHH(O). Implementing this step increases the basis for US and Australian tax purposes and is tax free from an US perspective. It is taxable from an Australian viewpoint but there should be no gain. (c) JHH(O) revalues investment in JHH(I), for Australian capital gains tax purposes. (d) JHH(O) pays a stock dividend to Australia. While a stock dividend is not subject to US withholding tax, from an Australian perspective, the dividend is exempt and increases the cost base in JHH(O). (e) RCI contributes JHH(O) to New US Co. The basis for US tax purposes is increased. Although the contribution is taxable in Australia, it should not have adverse consequences, because the basis was increased in step (d).' 54 The primary judge at [28] of her Honour's reasons makes the following observations on this section of the memorandum: 'The paper distinguishes between tax consequences of "off-market buyback" and "on-market buy back" in the context of repatriation of funds to shareholders. It also refers to a "step up in basis" of the US Group and lists steps by which this could be accomplished. While this aspect of the analysis may be related to FIRPTA rules that ultimately were not relevant, the memo clearly evidences a concern about capital gains tax issues. Following a comment that a stock dividend would not be exempt from tax in Australia, it also refers to an increase in cost base. The last step is that "RCI contributes JHH(O) to New US Co. The basis for US tax purpose is increased. Although the contribution is taxable in Australia, it should not have adverse consequences because the basis was increased in step (d)".' Her Honour's observations are correct save that the memorandum does not say that a stock dividend would not be exempt from tax in Australia; indeed, just the opposite. 55 The memorandum goes on to consider the enhanced structure considered in the memorandum referred to in [47] above with a Bermuda company as the float entity on top of a Luxembourg company to which the shares in JHH(O) will have been contributed, and the principal benefits of such a structure. 56 On 22 August 1997 Mr Clemens prepared a paper in which listing a Bermuda holding company was still presented as an alternative to the more basic concept of listing a US holding company. Certain notes relating to this paper made by Mr Morley and headed 'Tax Considerations - Skully' [sic] were also in evidence. 57 Some of the members of the Board of JHIL expressed reservations to Mr Morley about the use of a Bermuda company as a listed parent. He therefore asked C&L to consider alternative structures. In a paper sent to Mr Morley by Mr Clemens on 28 October 1997, C&L proposed a Luxembourg holding company structure. At the end of the paper, C&L raised the possibility of a Dutch holding company for the first time as an alternative to a company resident in Luxembourg. 58 Mr Morley was required to make a presentation explaining the proposal in November 1997. To assist him in making the presentation Mr Clemens forwarded him some slides under cover of a letter dated 4 November 1997. Mr Morley also had a lengthy telephone conversation with Mr Clemens in which Mr Clemens explained the benefits of the Irish finance company. The notes of that telephone conversation were in evidence. 59 In a memorandum dated 3 December 1997 from Mr Wilson of Warburgs to Dr Barton and Mr Morley, Mr Wilson proposed a process of 'Reverse Due Diligence' before going further with Project Scully. The process involved three key work streams: (1) legal review; (2) financial review; and (3) taxation review. 60 In early December, C&L, on the instructions of the JHIL Board, put together a C&L Scully Deal Team of partners and staff which was divided into sub-groups designated as: US GAAP Team, Tax & Structuring Team and Valuation Team. Mr Clemens was designated the overall Co-ordinator and Mr P Brunner as the SEC Registration US GAAP Co-ordinator. Attached to the list of members of the C&L Scully Deal Team was a timetable listing major tasks to be completed by 13 May 1998, when it was proposed that Project Scully would be announced. Also attached was a document dated 4 December 1997 headed 'Tax Structuring'; listing specific tasks to be accomplished between January and the second half of March 1998. It read: 'TAX STRUCTURING January Analyse tax forecasts and approximate values of group assets, by country. Determine levels of debt appropriate to each country Specific projects: • Debt creation in New Zealand • Debt creation in U.S.A. • Transfer pricing in Philippines • Australian loss recoupment • Australian asset transfer • Technology licensing and ownership February Develop unwind projects: • Hungary • Jersey • Kockums • New Zealand cross holdings • [N.B. keep Malta] Implement unwind projects Based on data from specific projects above (January), develop detailed structuring plan for Scully and create tax model Identify pre-31 March 1998 steps required Second half Refine structure with JHIL executives March A.E. Clemens 4th December 1997' In the course of cross-examination, Mr Clemens agreed that one of the 'pre-31 March 1998 steps' referred to in the plan 'was the payment of the dividend that was the subject of these proceedings', although at that time, December 1997, the only dividend proposed as part of Project Scully was a stock dividend, not one funded by a borrowing by JHH(O) as ultimately occurred. 61 In mid December 1997, a sub-committee of the JHIL Board was formed for the purpose of supervising the reviews proposed in Mr Wilson's memorandum of 3 December 1997, and to further develop the concept of reorganisation and listing on the New York stock exchange. The members of the sub-committee were Dr Barton, Mr Pedley, Ms Hellicar, Mr Michael Brown and Mr Morley. The first meeting of the sub-committee was held on 16 December 1997 when Mr Wilson and Mr Sweetman from Warburgs were also in attendance. The meeting notes record inter alia: '1. … • Tax Larry Magid of Allens to review the Newco structure. The company's US securities lawyers to review US and international aspects. PGM etc to brief Larry Magid pre Christmas. … 7. … • Danger of focusing only on the detail: 7 Need to continue to recognise and review the fundamental rationale for the transaction and avoid being swamped by the detail of the process (whether or not there are market fluctuations).' It seems that between the time that the agenda for this first sub-committee meeting was sent out on 9 December 1997 and the date of the meeting, 16 December 1997, the code name for the proposed reorganisation changed from 'Project Scully' to 'Project Chelsea', although others still used the former name after the latter date. Project Chelsea 62 On 23 December 1997, a Tax Review Meeting was held at which Mr Morley, Mr Michael Brown and Mr Pedley from JHIL, Mr Clemens from C&L, Mr Martin and Mr Magid from Allens and Mr Wilson and Mr Matt Coren from Warburgs were all shown as in attendance. The meeting notes record that Mr Clemens outlined the objectives and basic concepts of the Newco tax structure, the required restructuring of JHIL companies/assets and the impact on JHIL. The notes summarised the critical issues which included: 'Restructuring of JHIL companies/Assets • Restructuring issues for Australia and New Zealand are fairly straightforward with a mix of share sales and asset sales to effect the allocation of the rump. … • Detailed work needs to be conducted to determine the transfer arrangements for the US assets.' 63 On 21 January 1998 a meeting was held at the offices of C&L, Los Angeles, at which Mr Morley, Mr Harman and Mr Borgardt were in attendance along with representatives of C&L, from both Australia and the US, including Mr Clemens, Mr Sheppard and Mr Belanger. At that time, neither Mr Harman nor Mr Borgardt was aware of Project Chelsea and neither the Agenda nor the Outline of Discussion at the meeting record any reference to it. According to Mr Morley (not Mr Harman - see the primary judge at [31] of her Honour's reasons), the proposal to pay a dividend by 31 March 1998 was the main matter discussed at the meeting. This is reflected in the Outline of Discussion which reflects the perceived need to shift the tax burden of the Group from the US to Australia due to the significant tax losses in Australia. The Outline reads: 'James Hardie Industries Ltd Outline of Discussion at James Hardie Tax Planning Meeting On 21 January 1998 a meeting was held at C&L LA between PM, SH, BB, AEC, KDS, PB, SB, TN and RD to review the tax position of the JHIL group in the US and to undertake tax planning in respect of the group. Background It was generally agreed that there was a need to shift the tax burden of the group from the US to Australia due to the significant tax losses in Australia. The two primary means of achieving this objective were considered to be by moving the group's research costs to the US or moving gearing from Australia to the US. Currently the US has debt of $US458m (being $158m from Merrill Lynch 12 year issue at 9.25% and $300m of bank debt at $300m) and cash on deposit in Nevada of $US36m ie net debt of $US422m. It was proposed that this debt be increased by $US200m. It is not clear what the E&P balances of the group would be for the 1998 year. The E&P may be as low as zero depending on the outcome of a Rev Proc 96-31 study. However, assuming the 1998 E&P is $US10m, the E&P for JHH(O) would be $US10m and JHH(I) would be $US34m. There was a commercial desire to simplify the group structure were [sic] possible. Accordingly, provided the costs are not prohibitive, it was decided to liquidate the Hungary holding company. Issues The proposal to increase the gearing of the US group by $200m (and reducing the gearing of the Australian group) gives rise to the following issues:
25 RCI contributes the following assets (all 100% shareholdings) with the following values to Malta 1 in exchange for shares issued for par and premium. Malta 1 and Malta 2 (see steps 26) are established for Australian repatriation purposes. Value $M Asia 70 JHH(O) 320 Luxembourg 5 585 James Hardie Research (JHR) 75 $1,050 26 Malta 1 contributes the same assets to Malta 2 in exchange for shares issued for par and premium.' See 25 above.
66 Mr Morley gave the following evidence concerning this draft: '43 … In those reorganisation steps, (at Steps 1 - 5) the proposed cash dividend was reduced to $100m to address the borrowing constraints imposed by the borrowing covenants imposed on JHIL by the existing debt covenants with the balance of the dividend suggested to take the form of a "stock dividend" (as I understood it, the US term for what we, in Australia, term a "bonus issue". … 44 I was not in favour of paying a stock dividend because it did not achieve the objectives I desired and which I was endeavouring to achieve. As I had explained in the "James Hardie Business Plan Financials YEM 98 - 00" which I presented to the JHIL Board on 8 April 1997, it was desirable that JHH(O) borrow as much as possible to distribute a dividend so as to increase debt in the US and to increase funds available to invest to earn assessable income in Australia. I had also understood from Allan Brown's board papers dated 23 August 1996 and 23 September 1996 and discussions with various directors from time to time since my appointment as CFO that the board wished to achieve those objectives. For those reasons, I did not recommend the payment of a stock dividend to the board. Ultimately, no stock dividend was paid.' 67 According to Mr Morley, it was only at some time after 30 January 1998 that he became aware that JHH(O) could borrow internally (that is, from another member of the Group) without adversely affecting JHIL's compliance with its debt covenants. According to Mr Morley, internal borrowings would still increase the interest-bearing debt in the US and increase the interest receivable by the Australian companies. At some time after 30 January 1998 Mr Morley also became aware that JHH(O) could revalue JHH(I) by more than had been originally expected. 68 Meetings of the Project Chelsea Sub-Committee were held on 3 and 18 February 1998. The minutes of those meetings refer in the main to matters of detail, although the minutes of the first meeting record the rationale for Project Chelsea in the following terms: 'There are a number of aspects of the current structure that require addressing. The majority of profits and growth are in the US but shareholders and senior management are in Australia (in 1999 approximately 70% of EBIT). There are issues with the financial structure:
• The incremental tax benefit of the structure is estimated to be $12.5m (A$18.4m) on an annual basis, which will be fully reflected in accounting profits. (b) Step up in Australian Assets • A new Australian company will be established under the US Group to acquire the Australian assets. It is proposed that the assets be transferred at market value which will result in an A$100m uplift in tax basis for both Australian and US tax purposes. For tax purposes, Newco's new Australian subsidiary will have additional depreciation expense, calculated at A$100m over 7-9 years. The gain realised by JHIL on this sale will be taxable as ordinary income, but will be offset by the existing tax losses. The net effect is to transfer the existing tax losses in Australia to Newco as depreciable assets for both Australian and US tax purposes that are recovered over 7-9 years. This is estimated to create a tax benefit for Newco of $2.5m (A$3.7m) on an annual basis as well as being a permanent difference for accounting purposes. (c) Interest Double Dip • The structure will allow a deduction for the interest expense on the borrowings used to acquire the Australian assets in both the US and Australia. This involves securing a tax deduction on the interest expense on borrowings from the IFSC in both Australia and the US by using an Australian holding company that is a resident For Australian purposes and a "look through" for entity US purposes. The benefit in Australia is secured by transferring the holding company loss to the Australian operating company. The pre-condition for securing the benefit in the US is achieved by interposing a finance company that pays tax in Australia and, because it is a look through entity for US purposes , has a prima facie tax liability in the US, but has US foreign tax credits for Australian taxes paid. In effect, tax that would have been paid by the Australian operating company is transferred to the financing company to meet the pre-condition of US assessable income, while also generating foreign tax credits. The double interest dip in Australia will provide a tax benefit of $2.3m (A$3.4m) on an annual basis. • The benefit is secured in NZ by capitalising the NZ subsidiary with a hybrid debt/equity instrument (debt for NZ tax, equity for US tax). Under the New Zealand accruals rules, an interest deduction should be available in respect of the instrument but there would be no withholding tax payable until an actual distribution by the New Zealand company. For US tax purposes, amounts received on the deemed equity instrument would be taxable only on receipt. To the extent that the US group borrows to invest in the hybrid instrument, the US group should obtain tax deductions for this interest expense. The double dip on the hybrid instrument results in a tax benefit of a $5.9m (A$8.7m) on an annual basis. (d) Australian CFC Rules • Since the IFSC is not a subsidiary of the US group, it will not be liable for tax under the US Controlled Foreign Corporation ("CFC") rules. However, for as long as Newco is greater than 40% owned by JHIL, JHIL's assessable income will include its share (say 80% post the IPO) of the lFSC's taxable income. JHIL also receives foreign tax credits on its share of tax paid by the IFSC to offset against any tax payable on the CFC income under the Australian CFC rules. This will in effect, use JHIL's existing and ongoing tax losses (asbestos expenses). (e) Other • It is proposed that the Asian operations, which currently enjoy a tax holiday, will be held directly under the Netherlands holding company rather than under the US Group. This is to enable the repatriation of profits earned during the tax holiday without incurring US tax. • The diagram below summarises the purpose and benefits of the tax structure. 73 The notes of the meeting of the Project Chelsea Sub-Committee held on 3 March 1998 indicate that Sir Llewellyn Edwards and Mr Peter Willcox were present. This was the first time these directors had attended such a meeting. The notes show that the Briefing Paper referred to in [72] above was distributed prior to the meeting and state: 'Tax … C&L are preparing a detailed memo of advice that will sign off on the structure. C&L are meeting with Larry Magid later in the week to further progress his review.' The notes of the meeting also refer to a 'GMT [general management team] briefing 12 - 13 March' and that the Project Team be expanded by the inclusion of, among others, Mr Harman and Mr Bogardt 'post the GMT' briefing. 74 On the same day as the Project Chelsea Sub-Committee meeting was held, namely, 3 March 1998, Warburgs issued a 'Debt Financing Strategy - Working Paper' which, in relation to an overview of critical issues, read: 'A substantial restructuring of the debt financing structure is required prior to the listing of Newco. The critical issues to be considered in the debt financing strategy include: • Currently, JHIL has total debt outstanding of $850m and cash deposits of $420m, resulting in a net debt position of $430m. This is clearly not an optimal position from a balance sheet perspective. Project Chelsea provides the opportunity to improve financial efficiency by reducing both total outstanding debt and cash deposits whilst increasing the net gearing position.' 75 On 4 March 1998, the JHIL Board approved the terms of a proposed settlement of the Firmandale litigation. The proceedings finally settled later that month. 76 On 18 March 1998, the next meeting of the Project Chelsea Sub-Committee was held. Notes of that meeting record, inter alia: '1. Minutes from Previous Meeting … • Larry Magid (Allens) tax review - the meeting foreshadowed in the minutes for the Sub-committee meeting on 3 March occurred on Friday, 6 March. Conclusion from the tax review meeting was no "show stoppers" identified but Magid also waiting on detailed memo of advice from C&L to further his review. … 2. GMT - Presentation of Project Chelsea … • The project was well received by the GMT. Brad Bridges and Greg Baxter have large roles in the project and we are optimistic that they will move to the US. • Peter Shafron, Don Cameron, Steve Harman and Noel Thompson were told of the project after the GMT session and all reacted positively. Brian Borgardt (US financial controller) and Howard Barnhorst (US external counsel that effectively operates as internal counsel) will be told of the project on 23 March. … • JHIL personnel that will be aware of the transaction as at 23 March are listed below. Alan McGregor Keith Barton Michael Brown Sir Llewellyn Edwards Meredith Hellicar Peter Pedley Peter Wilcox Phillip Morley Greg Baxter Brad Bridges Ken Boundy Don Cameron Steven Harman Peter Macdonald Robert Middendorp John Moller Peter Shafron Noel Thompson Brian Borgardt Howard Barnhorst … 7. Next Steps • US management briefing and organisational meeting Monday 23 - Tuesday 24 March. … • Timing of the public announcement of Project Chelsea - matters will not be progressed sufficiently to announce on 13 May. Consequently, defer the announcement until 2 July, one week prior to the AGM and release and file this registration statement with the SEC at the same time. The timing of their IPO will not change as a result of the delay of public announcement.' 77 At [41] of the primary judge's reasons, her Honour made the following observations on the notes in [76] above: 'It is relevant that the minutes exhibit no doubt that the Project would go ahead. Their concern is with timing in the light of what still needed to be accomplished. Ultimately, the announcement was made on 30 June 1998. While it may be accepted that at this point the JHIL Group was not irretrievably committed to Project Chelsea in that the final sign-off by the Board had not occurred, it would be naÏve to assume that there was no commitment to the Project prior to that occurring. The tenor of the sub-committee minutes is of commitment to the Project with concern being directed to finalising the steps and resolving the multitude of issues inherent in such a complex project.' 78 On 23 March 1998 Mr Sheppard sent a facsimile to Mr Ryan Dudley of C&L Los Angeles (at [42] of the primary judge's reasons the description of this communication was incorrectly inverted) which read, inter alia: 'Dear Ryan SUBJECT: CHELSEA Thank you for your email dated 22 March 1998 regarding our discussions on matters to be carried out prior to 31 March 1998 in the US group. From our discussions and your note, I note the following: (a) It should be possible to have a discounted security in place for a term that is less than 183 days and not have a US interest withholding tax liability; (b) Payment of a dividend prior to 31 March 1998 and a loan back of the funds for repayment in the following year should be respected in the sense that there would be a dividend payment in the 1998 year and not in the 1999 year when the instrument is settled. (c) I understand that you are still following up on whether the 96-31 adjustment reduces E&P as well as the taxable income for the year to 31 March 1998. In relation to the US tax issues on the Chelsea reorganisation, we need to provide finalised advice to Gibson Dunn for them to review. Accordingly, together with Steve Booth and Pete Belanger, could you please arrange for our LA tax advice to be finalised. In particular, I would make the following comments: (a) I understand you have carried out some work on the interest stripping provisions and reached some tentative conclusions regarding interest deductibility in the new structure. The projections have changed in recent days and therefore some adjustment may need to be made to your calculations. However, could you please arrange for the work on this to be finalised once the new projected numbers are used in the analysis. (b) In relation to the dividend to be paid prior to 31 March 1998 as discussed above, we will need to obtain a firm view on the earnings and profits for the current year in order to calculate the dividend withholding tax. Accordingly, could you please arrange for such a number to be calculated (c) We have discussed the need for a valuation of the shares in JHH(I) held by JHH(O) to be carried out by Mike Wierwille. Based on this valuation, we will determine the amount of dividend to be paid and also the amount of the bonus issue of shares prior to 31 March 1998. Could you please liaise with all relevant persons in the LA office. (d) With regard to your opinion on the interest withholding tax and the IFSC, my comments are as follows: (i) in the second paragraph, we need to ensure that this is now final advice and not preliminary; (ii) in the discussion on Article 23(5) of the Irish DTA, because there is at intention to use two Luxembourg companies between the IFSC and the listed Netherlands company, we need to make reference to "at least 95% of the aggregate vote and value of all shares being earned directly or indirectly by 7 or fewer US citizens or residents of the US, Ireland NAFTA countries or EU countries". (iii) on the discussion towards the end under "implications of having no traditional history", could you please insert the issue we previously discussed regarding the old Irish/US Treaty. My understanding is that the old treat continues to be in force until 31 December 1998 with the provisions of the new treaty applying after that date. The plan was to propose prepaying 12 months interest for the 1999 calendar year in December 1998. Accordingly, the old treaty would apply to give a zero percent interest withholding tax without issues arising on the limitation of benefits clause. The new treaty would then be applicable for interest payments arising after 31 December 1999 after which time there will be a trading history in which to measure the 6% "substantially and regularly traded" tests. (iv) with regard to the specific type of Luxembourg company to be used, could I please ask that you liaise with Wybe Mebius on this. (e) With regard to the transfer of the Australian assets to an Australian subsidiary Chelsea, could you please arrange to research the following issues: (i) as part of the stamp duty planning on the transfer of the Australian assets, we are considering a separate transfer of just the plant and equipment from JH Coy to another Australian company prior to a sale to the Australian subsidiary of Chelsea. If the plant and equipment is transferred separately from the business, it appears we should obtain exemption from stamp duty. Furthermore, as there are significant losses in James Hardie Research, we are hoping to be able to utilise a substantial proportion of these losses in the year to 31 March 1998. Accordingly, James Hardie Research could then be transferred to Chelsea with a lower level of losses which will not be so useful in the Chelsea structure as in the former JHIL structure. The question therefore arises as to the cost base of the plant and equipment in the new Australian company after the transfer to the Australian subsidiary of Chelsea. Clearly, we are seeking to achieve a step up in the basis for depreciation purposes for the calculation of E&P once all the assets are under the US group. My understanding is that the US consolidation provisions should not be applied to the transaction carried out by subsidiaries of JHIL. Furthermore, as there is no liquidation taking place, the liquidation provisions should not apply. In addition, I cannot see that any of the reorganisation provisions would apply principally because there would not be a transfer by JH Coy of substantially all of these assets. Accordingly, a step up to fair market value basis should be achieved. I would be grateful if you could review this change to the proposed reorganisation and let us have your comments; (ii) also in relation to your memorandum on the transfer of Australian assets, we have had some discussions on the circular flow of cash. Perhaps you could review this issue prior to finalising your memorandum. (f) Regarding the application of the interest allocation rules and the Australian double dip structure, perhaps you could let us have your comments and recent opinions on the application of the US tax rules to the structure. My understanding is that the interest netting rules (as under Reg. 1.861-10T [unless these have now been finalised]) could potentially be applied in relation to the borrowings by Australian Hold Co if this was a single entity treated as a disregarded entity when the US checks the box on Australian Hold Co. We have previously discussed the possibility of getting around this problem by having Australian Hold Co as a partnership. In other words, there would be two shareholders in the company and the entity would be treated as a separate non-US entity when the US checks the box. The borrowing would be made by this separate US entity and not by the US consolidated group. My understanding is that this should solve this problem but perhaps you could provide us with confirmation. I will give you a call to discuss these issues in due course. If you have any queries, please do not hesitate to contact me. Regards Keith Sheppard' Repatriation of Profit for Year ended 31 March 1998 79 On 27 March 1998 Mr Harman, who by now was in the Project Chelsea 'loop', had a telephone conference call with a number of people including Mr Allan Brown and Mr Borgardt 'to discuss the status of the proposed repatriation of profits from the US, including the obtaining of a valuation of the fair market value of JHH(O)'s investment in JHH(I)'. Mr Harman prepared a file note of that call which read, inter alia: 'Conference call re USA dividend 27 March 1998 11.00 am Australian time Bryon Borgardt, Ginger Lester, Allan Brown, Steve Booth, John Galvin, Stephen Harman • Purpose of call - ensure on track for USA repatriation before end of March. • Overall concept
Effect over 3 years: Increased interest income in Australia following receipt of US$318m dividend from USA 90.0 Australian operations EBIT improvement 37.0 Litigation costs too severe in original forecast 19.0 Jersey fx settled at $47, not forecast $50 3.0 Savings in Australian Group Services 3.0 Insurance savings 4.0
Disclosure value of YEM01 tax losses per latest forecast (121.9)
SEH 31.3.98' 90 The following day, that is, 1 April 1998, Mr Harman sent an internal JHIL memorandum to various financial officers in the Group setting out the accounting entries to be made to properly reflect the borrowing and dividend payment that occurred the previous day. His memorandum read: 'Subject: USA Dividend - 31 March 1998 I am advised that on 31 March 1998 James Hardie (Holdings) Inc [JHH(O)] undertook the following transactions: • It borrowed US$298,000,000 from James Hardie Industries Ltd (JHIL) by means of issuing in favour of JHIL a promissory note with a face value of US$307,415,972 payable on 28 September 1998. JHIL advanced the proceeds of this borrowing to JHH(O) through a newly-created US$-denominated interco account between JHIL & JHH(O). • It declared and settled a dividend of US$318,000,000 to the corporation's sole shareholder, RCI Pty Limited. US$298m of the dividend was paid by interco account entry, with JHH(O) directing JHIL to account to RCI for the US$298m current account balance arising from the borrowing step above. US$20m of the dividend was paid by funds transfer. As RCI does not have a US$-denominated bank account, JHFL received the funds into its New York account, and will account to RCI for the funds received. • As withholding tax is required to be deducted from such dividends, US$2.38m was withheld by JHH(O) from the gross dividend declared, and will be remitted to the IRS. Thus only US$17.62m was credited to the JHFL bank account. The withholding tax suffered should be taken up as an expense by RCI. Would the financial officers noted above please process the attached entries in the legal entities for which they are responsible.' Onward Project Chelsea 91 On 31 March 1998, there was a meeting of directors of James Hardie Fibre Cement Pty Limited the minutes of which record the proposal for that company to purchase the plant and equipment of James Hardie & Coy Pty Limited and James Hardie Fibre Cement Pty Limited for fair market value at 31 March 1998 as determined by C&L, and then for the company to leaseback the said plant and equipment at fair market value as determined by C&L. In cross-examination, Mr Morley, who was in attendance at this meeting, agreed that this transaction was part of the preparation for Project Chelsea. 92 On the same day, 31 March 1998 there was a meeting of the Chelsea Sub-committee. The notes of this meeting were paraphrased by the primary judge at [52] of her Honour's reasons in the following terms: 'The notes of that meeting contain a progress report which includes comments about: the difficulties encountered in the CEO search; the progress of the search for non-executive directors and personnel for the proposed new company; and the preparation of a communication plan including a plan for addressing leaks about the Project. Under the heading of "Timing and Key Actions" the notes refer, inter alia, to the financial plan and model for Project Chelsea, the detailed financing plan being prepared, the intention to hold a Board meeting on 3 June. The notes indicate that the public announcement of Project Chelsea was still planned for 2 July 1998 and state that "It is intended to bring the Australian analysts from [Warburgs] and the co-managers across the Chinese wall approximately a week or so prior to the announcement of Project Chelsea" the purpose being to "enable them to fully understand the transaction and be able to provide investors with an informed opinion".' 93 Following the finalisation of the financial statements for the year ended 31 March 1998, Mr Morley's attention was devoted to the preparation of the papers to be presented to the 2 June 1998 JHIL board meeting, at which the board would consider whether or not to proceed with the reorganisation and listing on the New York Stock Exchange. At [53] of her Honour's reasons the primary judge observed: 'Warburgs circulated a detailed checklist of issues dated 22 April 1998. The checklist shows that a public announcement on 2 July was still contemplated and that the roadshow presentations in support of the IPO for the new company (now referred to as "Newcastle") were scheduled for 9 to 23 September. Mr Morley noted that among the issues remaining to be determined was whether the stock issued on the New York Stock Exchange would give investors a 15% or 20% interest in the James Hardie Group.' Importantly, in our view, the Warburg checklist included the following item: '12. Costs • Stamp duty advice (transfer of companies where possible, separation of trademarks, intellectual property, i.e. federal assets, etc). Draft model prepared and being further refined as information is available. • Legal fees - cost end February by AAH. Secure quote and fixed cost from Gibson Dunn. GDC currently working on a "getting to know" the client and transaction basis and will provide a fixed quote after an initial period when they better understand the scope of their role. The cost of the initial period is estimated at US$50,000 - 75,000 and will be billed at 75% of normal rates. AAH to provide updated estimate. • Internal asset transfers. • C&L fees to end of February and estimate of further costs to be provided. • SBCWDR advisory fees. • Treatment - tax and accounting offer.' (Emphasis added.) 94 Minutes of the JHIL board meeting held on 2 June 1998 record that a decision to proceed with the reorganisation and listing proposal was discussed but deferred, to be further considered at the 30 June 1998 meeting. 95 On 30 June 1998 the board of JHIL approved the announcement of the implementation of Project Chelsea and resolved to take the proposal to shareholders for approval. A media release announcing the reorganisation and capital restructuring was made on 2 July 1998. Under the heading 'Shareholder Information', the media release read: 'Certain aspects of the plan require shareholder approval. This will be sought via ordinary resolutions at an Extraordinary General Meeting which the company intends to hold in Sydney on September 25, 1998. The Board expects that a Notice of Extraordinary Meeting and an Explanatory Memorandum will be sent to shareholders in late August, detailing the plan and relevant considerations, to enable shareholders to cast a fully informed vote. The Explanatory Memorandum will include an Independent Expert's Report which is being prepared by Grant Samuel & Associates Pty Limited.' 96 Following the resolution of the JHIL board on 30 June 1998, the internal reorganisation necessary to separate the US operations into the new holding company structure commenced. On 28 July 1998 a further draft action plan was received from PwC. In that action plan, the proposal to establish an Irish finance company was substituted with a proposal to establish a Dutch finance company. This was necessary because of changes to the tax rules applying in Ireland. The proposal to proceed with a Dutch finance company, known as James Hardie Finance BV ('JHFBV') was approved by the JHIL board on 5 August 1998. In August 1998, James Hardie NV ('JHNV'), the proposed US-listed vehicle was established. 97 Once the establishment of JHFBV was approved the process of raising external debt for the purpose of refinancing the US operations began. On 7 August 1998, a private placement memorandum for Guaranteed Senior Debt Notes totalling $225,000,000 was issued. The Notes were to be guaranteed by the parent of the US operations, JHNV and not by JHIL. This enabled creditors to issue debt to companies unaffected by the legacy assets and liabilities retained by JHIL, including asbestos liabilities. As a result, debt was offered by lenders at a lower interest rate than existing debt and for a longer term than the existing debt. 98 Throughout August, work progressed on the drafting of the Information Memorandum to be distributed to JHIL shareholders to enable their approval for the restructure to be obtained and on implementing the internal corporate reorganisation necessary to facilitate a listing of JHNV. The internal corporate reorganisation involved the transfer of operating assets and companies from the JHIL Group to a newly formed group to be owned by JHNV ('JHNV group'). 99 To enable JHFBV to earn the maximum amount of interest from loans to the operating companies it was necessary that it would be the borrower of all money borrowed from external parties, which it would then on-lend to the operating companies in the United States, Australia and elsewhere. It was also desirable for all internal lending to originate with JHFBV. It was therefore necessary for the JHNV group to refinance money lent to it by the JHIL Group and establish a new debt funding structure. Accordingly, all inter-company loans between companies in the JHNV group and the JHIL Group had to be repaid as part of the reorganisation. 100 Prior to the refinancing, the US companies that formed part of the JHNV group owed the JHIL Group companies US$394.4 million (US$307.4 million to JHIL and US$87 million to James Hardie Finance Ltd ('JHFL')), of which US$298 million was attributable to the dividend JHH(O) paid to RCI in March 1998. The US companies also had external borrowings of US$398 million, which were being refinanced as part of the reorganisation. As a result, these loans totalling US$792.4 million needed to be refinanced or repaid by the US companies. The total amount of new external debt available to the JHNV group (and therefore to the US companies) was limited by the thin capitalisation rules applicable in the United States (known there as 'earnings stripping' rules). It was necessary for further capital to be contributed to the US to ensure that the 'earnings stripping' rules were not breached. PwC initially estimated that the amount was approximately US$179.8 million. This situation was undoubtedly contributed to by the March 1998 dividend of US$318 million, but it exemplifies the point made at [32] above that the object of repatriating assets to Australia to generate income in Australia and deductions in the US by measures such as the transaction, were at odds with the objects of Project Chelsea. 101 To inject the further equity into the US, RCI was required to subscribe for further shares in JHH(O) (in addition to the 500 shares already held) in the amount of US$179.8 million which represented the estimate of the amount by which capital needed to be injected in order to comply with the 'earnings stripping' rules. Later, PwC advised that the amount of capital needed was only approximately US$50.2 million. 102 On 26 August 1998, a share subscription agreement was signed on behalf of RCI for the acquisition of 570 shares in JHH(O) for US$50,229,768. The proceeds owing under this agreement were paid by RCI tendering to JHH(O) a negotiated promissory note issued by JHIL on 23 September 1998 (see [112] below). 103 On 17 August 1998, RCI resolved to transfer its shares in JHH(O) to RCI Malta in consideration for shares to be issued by RCI Malta equal to the fair market value of JHH(O). Although the sale was resolved upon and approved on 17 August 1998 the shares in JHH(O) were not transferred to RCI Malta until 15 October 1998, only after JHIL unconditionally committed itself to the Project on 7 October 1998 (see [117] below). 104 RCI received a copy of a valuation of JHH(O) prepared by Mr Harman in the form of a memorandum dated 26 August 1998. That valuation ascribed a market value of US$88,122.40 for each JHH(O) share, so that the total market value of JHH(O) shares to be sold was US$94,290,968. 105 On 1 September 1998 there was a meeting of the JHIL board. At that meeting Mr Clemens reported that the Australian Taxation Office had issued an advance opinion dated 1 September 1998 indicating that JHIL could return to shareholders capital raised by JHNV free from income tax and with capital gains tax deferred. Mr Wilson of Warburgs reported that capital market conditions in the US had become volatile, and there was an emerging concern that the expectations of the price at which JHIL would be able to float JHNV might not be achievable. However, the JHIL board resolved to continue with Project Chelsea and in particular to proceed with the necessary corporate restructuring; to call an extraordinary general meeting of shareholders on 16 October 1998 and to sell up to 17.25% of the shares in JHNV to the public. 106 As a result of the JHIL board's resolve to continue to proceed with the reorganisation and the float of the US operations, JHIL could no longer continue to prepare its financial statements on the basis that it was virtually certain that it would be able to offset its Australian tax losses and timing differences between taxable income and accounting profit against future Australian assessable income. This was because it would not be possible to transfer losses of JHIL and its wholly owned subsidiaries to JHNV and its wholly owned subsidiaries (because, after the initial public offering, JHNV and its subsidiaries would not be wholly owned by JHIL). On 10 September 1998, there was a meeting of the JHIL audit committee that considered the accounting issues arising with respect to the preparation of the financial statement for the half year ended 30 September 1998. At that meeting it was noted that following the reorganisation, FITBs totalling approximately $100 million were not now expected to meet the requirements of the virtual certainty test and therefore were required to be written off once shareholder approval for the reorganisation was obtained. The first quarter results for the three month period ended 30 June 1998 were released on 18 September 1998. As shareholder approval for the public offering had not been obtained, the first quarter results continued to show the FITB as an asset on the balance sheet. However, the announcement of those results also foreshadowed that if approved by shareholders, the reorganisation would result in a write off of $106 million of the FITB. 107 On 16 September 1998 an Information Memorandum dated 14 September 1998 was circulated to JHIL shareholders together with a notice of meeting to be held on 16 October 1998 to consider resolutions to approve the offering and listing on the New York Stock Exchange of approximately 15% of JHNV and a reduction of capital of JHIL, with a unanimous recommendation of directors to JHIL shareholders to vote in favour of the proposal. The Information Memorandum was accompanied by an independent expert's report prepared by Grant Samuel & Associates Pty Limited. 108 In our view, this is one of at least two very important contemporaneous documents in terms of the contribution its content makes to the tasks that the Court has to undertake in deciding whether, as alleged by the Commissioner: (1) RCI obtained the tax benefit in connection with the scheme; and if so, having regard to the eight matters in s 177D(b); (2) the dominant purpose of one or more of the parties which entered into or carried out the scheme, or part of the scheme, was to enable RCI to obtain a tax benefit. 109 It relevantly provided in 'Part 4: Other Considerations for Shareholders', under the heading: '3. Disadvantages of the Proposal', the following: 'Transaction Costs The implementation of the Proposal will incur transaction costs estimated at approximately $35 million including all fees for advisers and costs contingent on the Proposal being implemented, such as stamp duty but excluding the Underwriters' discount of approximately 6% of gross proceeds. This includes costs associated with the implementation of the Debt Refinancing which would, at least in part, be required even if the Proposal as a whole was not pursued. Approximately, $14 million of these costs have been incurred or committed to develop and advance the Proposal to this stage.' 110 Under the heading: '5. Implications of Not Pursuing the Proposal' and the heading '6. Other Alternatives Considered' the Information Memorandum considered, under the first head, the relative merits of implementing or not implementing the proposal and, under the second head, stated that the 'benefits and disadvantages of the Proposal have been rigorously tested against other alternatives'. Significantly, under the first head of not pursuing the proposal, the memorandum states: 'As the Company has substantial Australian tax losses, it is not expected to pay Australian tax in the foreseeable future'. Under the second head, it states: 'A number of the more significant alternatives considered by the Board and their general implications are discussed below. It should not be assumed that the Board would be prepared to pursue any of these alternatives. Indeed, the Board is of the view that the Proposal represents the only alternative which comprehensively addresses the fundamental structural and the financial issues facing the Company. The implications of not pursuing the Proposal (ie effectively carrying on with business as usual) have been outlined in Section 5 of this part.' In conclusion under the second head, it states: 'While each of these alternatives considered by the Board has some attractions, they only partially address the structural imbalances within the Company and, in the view of the Board, do not provide as complete a solution to the structural imbalances as the Proposal. Once the restructuring is completed, some of these alternatives may once again be considered, including merger or joint venture proposals or the trade sale of operations.' 111 On the matter of 'transaction costs', Grant Samuel's independent expert's report reads: 'Transaction costs The restructuring will incur transaction costs (such as interest rate swap break costs, stamp duty, advisory fees and legal expenses). These costs are estimated to be approximately $35 million of which approximately $14 million is expected to have been incurred or committed by the time of the initial public offering. These fees are one off costs and are not significant in the overall context of James Hardie Industries. They represent 2.5% of market capitalisation.' (Emphasis added.) 112 As noted at [99] above, it was necessary to refinance the Group's debt so that JHFBV became the principal lender to other companies within the Group. The following steps were taken to bring this about. On 23 September 1998 JHIL issued RCI with a promissory note of US$50,229,768 ('PN2') in part payment of the debt owed by JHIL to RCI of US$298 million. This resulted in the amount owed by JHIL to RCI being reduced to US$247,770,232. RCI, in satisfaction of the liability outstanding, in respect of the share issue on 26 August 1998, assigned PN2 to JHH(O). 113 On 25 September 1998, the board of RCI resolved, in place of resolutions passed on 17 August 1998, that RCI should - (a) borrow US$50 million from JHIL via a promissory note; and (b) accept repayment from JHIL of inter-company loans via promissory notes to value of US$650 million, including inter-company debt of US$298 million arising from the dividend paid by JHH(O) on 31 March 1998. 114 On 28 September 1998, JHH(O) assigned PN2 to JHIL in partial satisfaction of the amount payable under PN1 which reduced the amount still owing under PN1 to US$257.2 million. On the same day, JHH(O) borrowed US$257.2 million from JHFL to settle the balance of the amount owing to JHIL under PN1. This fully discharged the remaining debt owing under PN1. 115 On 2 October 1998, JHIL issued a promissory note ('PN3') to RCI with a face value of US$675 million in satisfaction of inter-company debt, including the debt of US$247,770,232 owing by JHIL to RCI after the part payment on 23 September 1998. PN3, acquired by RCI on 2 October 1998, was subsequently dealt with as follows: (a) RCI assigned PN3 (for US$675 million) to RCI Malta in consideration for an equivalent value in shares in RCI Malta; (b) RCI Malta then assigned the note to its wholly owned subsidiary company, RCI Malta Investments Limited ('RCI Malta 2'), in consideration for an equivalent value of shares in RCI Malta 2; and (c) on 9 October 1998 RCI Malta 2 contributed PN3 to JHFBV, in exchange for shares worth US$675 million. JHFBV lent back US$258 million to JHH(O). 116 The effect of the contribution of PN3 by JHIL through RCI and the two companies in Malta was that money owing by the US group to JHIL and to JHFL became money owing by the US group to JHFBV. This indebtedness included the indebtedness created by the dividend that JHH(O) paid in March 1998 to RCI. 117 The volatility in the US markets continued throughout September. Doubts about the viability and timing of a public offering continued to emerge. Although equity markets remained volatile, work continued on the refinancing of the existing debt within the JHIL group. The debt refinancing would lower the cost of debt to the Group even if the public offering did not take place. Because the debt refinancing also required the internal reorganisation to be completed, it became necessary to proceed with the reorganisation even if the public offering did not proceed. To this end, the board of JHIL resolved to implement the reorganisation on 7 October 1998. Rather than issue an update to shareholders on the viability of the public offering, the update was announced to shareholders as part of the Chairman's address to the extraordinary general meeting on 16 October 1998. 118 On 12 October 1998, JHIL issued a further promissory note to RCI for US$49 million. On 15 October 1998, RCI disposed of its shares in JHH(O) valued at US$94,290,968 to its wholly owned subsidiary, RCI Malta in exchange for 94,290,968 shares in RCI Malta. RCI also assigned the promissory note of US$49 million to RCI Malta in exchange for shares in RCI Malta. RCI recorded a capital gain of $45,971,764 in respect of the disposal of JHH(O), which it returned as a taxable capital gain in its income tax return for the year ended 31 March 1998. 119 At the extraordinary meeting of shareholders of JHIL on 16 October 1998 the shareholders resolved to approve a public offering of 15% of the shares in JHNV. At that meeting, the Chairman addressed shareholders and the text of that address is the second important contemporaneous document contributing to the determination of the issues before the Court in [108] above. Under the heading: 'The Proposal', it read: 'There is no doubt that this is a complex proposal. I will take a few moments to reiterate the key points. The Board and its advisors spent 18 months evaluating the structural issues facing the company and the alternative solutions to those issues. This is the only proposal which, in our view, comprehensively addresses all of the issues facing the company. This view is supported by an Independent Expert's Report which was prepared by Grant Samuel & Associates. Because we have filed a Registration Statement in the United States for the offering of securities in James Hardie NV, the company is deemed by US regulators as being "in registration". Consequently, we are unable to provide specific financial forecasts for our businesses, or on the proposal itself. Nevertheless, I can share with you some facts about the future. In analysing our options, we compared forecast financial outcomes from the new structure with forecast outcomes from the current structure. When considering key financial indicators, the new structure produced superior outcomes, such as higher operating income and cash flows, lower tax rates, a lower cost of capital and lower effective interest rates. More importantly, because of the structural issues we face, we believe the outcomes from the current structure could deteriorate over time. By comparison, over the same period, we expect the improvements available from the new structure will continue to escalate. For example, in three or five years time, the gap between the positives afforded by the new structure and the negatives associated with the current structure, is expected to be wider than at present and continue to widen. Doing nothing, as some people have suggested, is therefore not an option the Board could sensibly or responsibly contemplate. Because of the more efficient tax structure, we expect the after tax returns available from the businesses to improve. As a result we expect there will be higher cash flows available to either reinvest in the operating businesses, or return to shareholders in the form of dividends. We believe all shareholders will benefit from the structure, irrespective of whether they are Australian or American, or whether they hold shares in James Hardie Industries or James Hardie NV. … Some people have rightly questioned the cost of this proposal. The costs reflect the extensive restructuring involved which, in effect will reposition the company for the future. The Board has exercised great care to ensure that the costs are no higher than they need to be. It should be remembered that the costs, although high, are one-off items, whereas the financial benefits will accrue from the first year and may continue to grow. Indeed, the more successful we are in the United States, the larger the benefits could become, as a direct consequence of implementing the restructuring.' (Emphasis added.) 120 Throughout November and December Warburgs monitored the state of the US markets with a view to ascertaining an appropriate pricing structure for the initial public offering. On 5 February 1999, the board of JHIL resolved to include an indicative price range of US$15-18 in the prospectus for JHNV and to print and distribute the prospectus. In February 1999 Mr Morley travelled to Europe and the United States to undertake 'roadshow' presentations on JHNV to build up institutional interest in the public offers. 121 The feedback from the institutions at those presentations suggested that, in their view, the proposed pricing was too high and there was a demonstrable lack of support for participation in a public offering. On 3 March 1999, Warburg's recommended to the JHIL directors that the price range be revised down and on 4 March 1999, recommended a price range of US$12-14. The Board accepted this recommendation. 122 Mr Morley continued to present at the roadshows, but the level of interest was not increasing. On 5 March 1999, Mr Morley again attended (by telephone from New York) a meeting of the JHIL board at which Warburgs suggested that the board consider an offer price of US$11 per share, but that it was likely that the shares in JHNV would trade at below this issue price after the initial public offering. Following the receipt of this advice, the board resolved not to proceed with a sale of the shares in JHNV. 123 The collapse of the proposed sell-down left JHIL with a financial structure which was not appropriate given that there was to be no separate listing and ownership of James Hardie's US operations. Notwithstanding that the float of JHNV was not to proceed, the accounting standards did not permit JHIL to reinstate the FITB referable to the Australian tax losses. Furthermore, because the shares in JHNV were not going to be listed, the conditions for the favourable Dutch tax treatment of JHFBV would not be satisfied. Dividends payable from the JHH(O) to the Netherlands would be subject to tax of 30% and interest payable from the US to the Netherlands would be subject to a withholding tax of 30% with no credit for the US tax in the Netherlands. This meant that the Group had to 'relocate' the debt. This was done by creating a new finance company in Australia, which was a subsidiary of JHFBV, and contributing the equity of JHFBV into the new subsidiary. 124 We turn to consider the relevant issues. Did RCI Obtain the Tax Benefit Alleged by the Commissioner? The Nature and Object of the Enquiry 125 For Pt IVA to apply, s 177D(a) requires that the taxpayer has obtained, or would but for s 177F obtain, a tax benefit in connection with a scheme. Section 177C(1) relevantly provides that a reference in Pt IVA to the obtaining by a taxpayer of a tax benefit in connection with a scheme shall be read as a reference to - '(a) an amount not being included in the assessable income of the taxpayer of a year of income where that amount would have been included, or might reasonably be expected to have been included, in the assessable income of the taxpayer of that year of income if the scheme had not been entered into or carried out.' 126 The terms of this section are cast in the alternative; the Commissioner's power to make a determination rests on the existence of a scheme in connection with which, but for s 177F, a tax benefit would have been obtained or alternatively might reasonably be expected to have been obtained. The inclusion of the alternative was designed to provide for the case where the evidence falls short of establishing a fact and establishes no more than a reasonable expectation. Section 177E was designed to overcome, in the case of a scheme of dividend stripping, a perceived difficulty for the evidence to establish even a reasonable expectation; hence the statutory deeming that is built into s 177E(1) by paras (e) and (f). 127 In Commissioner of Taxation v Peabody (1994) 181 CLR 359 at 382, the High Court made it clear that the existence of a tax benefit is to be established as an objective fact and is not a matter of the Commissioner's opinion or satisfaction that there is a tax benefit. Moreover, where at 385 the High Court said - 'A reasonable expectation requires more than a possibility. It involves a prediction as to events which would have taken place if the relevant scheme had not been entered into or carried out and the prediction must be sufficiently reliable for it to be regarded as reasonable [see Dunn v Shapowloff [1978] 2 NSWLR 235 at p. 249, per Mahoney J.A.].' the reference to 'prediction' can be read as a prediction based on objective enquiry and determination. 128 It is trite that a taxpayer in this Court bears the onus of proving that an assessment is excessive: s 14ZZO(b)(i) of the Taxation Administration Act 1953 (Cth). It follows that it is the taxpayer who bears the onus to establish that a tax benefit is excessive. It might do that by establishing that there is no tax benefit or by establishing that it is less than that determined by the Commissioner: Federal Commissioner of Taxation v Trail Bros Steel & Plastics Pty Ltd (2010) 186 FCR 410 at [35] and [36] per Dowsett and Gordon JJ, Edmonds J agreeing [62]; Federal Commissioner of Taxation v AXA Asia Pacific Holdings Ltd (2010) 189 FCR 204 at [134] per Edmonds and Gordon JJ, Dowsett J agreeing [1]. 129 It has been said in the past, and the learned primary judge at [88] of her Honour's reasons said below, that the taxpayer carries the onus of establishing that the Commissioner's counterfactual is unreasonable; and that if the taxpayer does not establish that the Commissioner's counterfactual is unreasonable, then the taxpayer fails to prove that the assessment is excessive on that ground. (Of course, the taxpayer may establish that the assessment is excessive on some other ground, such as that the conclusion required to be drawn as to the dominant purpose of a party to the scheme under s 177D(b) cannot be drawn, but that is another matter.) 130 Such an articulation of the onus is erroneous, but if not, certainly unhelpful because it can lead one into error. Even if a taxpayer establishes that the Commissioner's counterfactual is unreasonable, it will not necessarily follow that he has established that the assessment is excessive. That is because the issue is not whether the Commissioner puts forward a reasonable counterfactual or not; it is a question of the Court determining objectively, and on all of the evidence, including inferences open on the evidence, as well as the apparent logic of events, what would have or might reasonably be expected to have occurred if the scheme had not been entered into. Thus, even if a taxpayer establishes that the Commissioner's counterfactual is unreasonable, that will not discharge the onus the taxpayer carries if the Court determines that the taxpayer would have or might reasonably be expected to have done something which gave rise to the same tax benefit. 131 That such an articulation of the onus is at worst erroneous and at best unhelpful, can also be illustrated from the other side of the coin, because it implies that if the Commissioner's counterfactual is reasonable that is the end of the matter; even if the Court were to conclude, on all the evidence, inferences and logic referred to, that if the scheme had not been entered into the taxpayer would have or might reasonably be expected to have done something which did not give rise to a tax benefit, or which gave rise to a tax benefit less than that thrown up by the Commissioner's counterfactual. In our view, that cannot be correct. 132 In saying this, we are mindful that when seeking special leave to appeal to the High Court in AXA [2011] HCA 63 (11 March 2011), the Commissioner's first ground was that s 177C was 'a gateway provision rather than a major forensic exercise'. He submitted that, to satisfy s 177C - '[I]t is enough if it might reasonably be expected that the amount would be included in the assessable income in the sense that there might be a number of reasonable expectations and it is sufficient if, on any one of those, the amount would have been included in the assessable income.' This no doubt explains the submission of senior counsel for the Commissioner towards the end of the hearing of the present appeal: '[W]e submit our submission is reasonable… We don't say it is the only counterfactual. We don't even say it is necessar[ily] the most probable counterfactual, but it meets the threshold.' However, we are comforted in the view we have come to by the fact that the Commissioner's special leave application was dismissed without counsel for AXA being called on. Of the first ground, the Court simply said: 'The first point is a question of construction in relation to which the Full Court of [the Federal Court] had taken a particular approach. We think there are insufficient prospects of disturbing this approach on appeal.' Discharging the True Onus 133 It has been said on more than one occasion in recent times that how a taxpayer goes about discharging the onus of proving that the taxpayer did not obtain a tax benefit in connection with a scheme, or of proving that the taxpayer only obtained a tax benefit less than that determined by the Commissioner, is a matter for the taxpayer: Trail Bros at [36]. 134 It may, for example, lead evidence that the taxpayer would have undertaken a particular activity, or adopted a particular course, in lieu of the scheme; or it may lead evidence that the taxpayer would not have undertaken a particular activity, or adopted a particular course, in lieu of the scheme: see, for example, Commissioner of Taxation v News Australia Holdings Pty Ltd [2010] FCAFC 78. Generally, such evidence is unlikely to be sufficient to discharge the onus unless it is supported by objective indicia to be gleaned from the context and matrix of underlying or 'foundation' facts, as they have been called (see McCutcheon v Federal Commissioner of Taxation (2008) 168 FCR 149 at [37] - [39] per Greenwood J) as well as the logic of the taxpayer's counterfactual having regard to the commercial or financial aspirations and limitations of the parties to the scheme; without such support, such evidence is likely to be regarded as no more than purely speculative. 135 On the other hand, in a given case, such evidence may not be necessary because, for example, the result of any objective enquiry as to the counterfactual is, at best, inevitable or, at worst, compelling. In such a case, the failure to lead evidence to say that the taxpayer would have undertaken a particular activity or adopted a particular course, in lieu of the scheme; or the failure to lead evidence that the taxpayer would not have undertaken a particular activity, or would not have adopted a particular course, in lieu of the scheme, will not lead to the taxpayer failing to discharge the onus. 136 Yet again, a taxpayer may not lead any direct evidence, but establish that there is no tax benefit through expert evidence: see Futuris Corporation Limited v Commissioner of Taxation 2010 ATC 20-206. And as Peabody itself establishes, the absence of any tax benefit obtained in connection with the scheme might be established by demonstrating the illogicality of the taxation consequences upon which the Commissioner's counterfactual is predicated, in that case the lack of any rebate of tax on dividends on the Kleinschmidt shares held by TEP Holdings as trustee. The Present Case 137 As noted in [11] and [12] above, the Commissioner calculated the tax benefit on the basis that had the scheme not been entered into or carried out, it might reasonably be expected that a reorganisation of the Group, involving the transfer by RCI of its shares in JHH(O) to RCI Malta in exchange for shares in that company, would nevertheless have proceeded notwithstanding it involved an additional transaction cost of $188.7 million ($172.1 million after allowance for losses and other tax credits). It is to be observed that the Commissioner did not put his case on the higher level that, in lieu of the scheme, RCI would have nevertheless transferred its shares in JHH(O) to RCI Malta, but only on the lower level that, such a course was one which, in lieu of the scheme, might reasonably be expected to have occurred. The Primary Judge 138 As observed above, the primary judge's conclusion on this issue was that RCI had failed to discharge the burden of proving that the Commissioner's counterfactual was unreasonable (at [88] of her Honour's reasons) rather than finding what might reasonably be expected to have occurred if the scheme had not been entered into. Unsurprisingly, her Honour's reasons for reaching the conclusion she did were directed to that conclusion rather than the statutory one. For example, at [85] of her Honour's reasons, her Honour said: (1) 'There is a wealth of evidence … that satisfies me that Project Chelsea was the means selected by the Board of JHIL to address the very real concerns held by it and its senior executives and advisers about the profit imbalance between the Australian and US operations of the JHIL Group. It is clear that the problem was ongoing and that there was no expectation that the trend of increasing imbalance would be reversed. Project Chelsea was expected to provide a lasting solution to this problem.' (2) 'The notes of the meeting of the Chelsea Sub-Committee of 3 February 1998 [see [68] above] stated that the sub-committee concluded that the commercial rationale for the Project was compelling and that for its value and growth [prospects] to be fully realised "JHIL must become a US based company"…' (3) 'In order to effect the restructure involved in Project Chelsea it was necessary for the JHIL Group's operations to be rearranged so as to be concentrated in the United States. The transfer of RCI's shares in JHH(O) to RCI Malta was part of that rearrangement.' Those three matters are undoubtedly relevant to a conclusion about whether the Commissioner's counterfactual is reasonable or unreasonable, but they contribute very little, if anything at all, to an objective enquiry and determination amongst alternative possibilities as to which is the most reliable prediction, that is, what RCI might reasonably be expected to have done if it had not entered into the scheme. 139 Similarly, at [86] and [87] of her Honour's reasons, her Honour said: (1) RCI did not provide any evidence to support its submission 'that without the benefit of the dividend the transfer of RCI's shares in JHH(O) could not reasonably be expected to have taken place'. (2) 'RCI invites the Court to draw this inference seemingly as a matter of commercial logic, however, its submissions go beyond what could be so inferred. … [S]uch observations do not substitute for evidence'. (3) Similarly, no evidence was adduced to support RCI's submission 'that it could not be reasonably expected that JHIL would have put to its shareholders a proposal that would carry with it a tax liability in the amount calculated by the Commissioner'. And her Honour accepted the Commissioner's submission 'that in view of RCI's failure to lead evidence from any one of Messrs Brown, Morley, Clemens and Harman about the alternatives to the disposal of RCI's shares in JHH(O) available to the JHIL Group it must be inferred that such evidence would not have assisted it'. Her Honour referred to the observations of Handley JA in Commercial Union Assurance Company of Australia Ltd v Ferrcom Pty Ltd (1991) 22 NSWLR 389 at 418 concerning the application of the principles of Jones v Dunkel (1959) 101 CLR 298, rather than the Court drawing inferences favourable to a party when no attempt was made to prove them by direct evidence; by asking questions of a witness in chief. 140 Those matters may well contribute to a conclusion that RCI has not established that the Commissioner's counterfactual is unreasonable, but that is not the statutory question. As indicated above, the statutory question is one for objective enquiry and determination - what the taxpayer might reasonably be expected to have done if it had not entered into the scheme - and the answer to that question is more likely to be found in the underlying or foundation material before the Court than in any evidence led by the taxpayer as to what it might have or might not have done; or in its failure to lead any such evidence. That is not to say, in a given case, that the leading of such evidence and its testing in cross-examination, or the failure to lead such evidence, may or may not assist the Court. But in the vast majority of cases, the objective enquiry and determination will be answered by the underlying or foundation material before the Court. That this may be a recipe for uncertainty of outcome in any given case is to be regretted, but if it is to be criticised as too dependent on the judgment of the Court, that is a criticism to be directed at the architecture of the legislation and not the processes of the Court. Analysis and Conclusion 141 There is no doubt that the proposal that was ultimately put to JHIL shareholders for approval was the preferred course of JHIL, its directors and advisers, over either: (i) doing nothing; or (ii) adopting and pursuing one of the number of alternatives considered by the JHIL board, against which the benefits and disadvantages of the proposal had been 'rigorously tested'. All the relevant contemporaneous documents support this conclusion and we have no doubt that even if the parameters upon which that preference was predicated changed such as to adversely impact on perceived future economic or financial benefits then, provided that impact was marginal, recommendation of the proposal would have nevertheless been forthcoming and, with the benefit of that recommendation, the proposal would have been approved and proceeded. 142 On the other hand, it is to be observed that the transaction impugned as the narrower scheme, or it and the other steps which together are impugned as the wider scheme, are but one or very few in number of many steps encompassed by the proposal involving, as it does, a voluntary reorganisation born out of a belief by JHIL's senior financial executives and its external financial advisers that, despite the cost of doing so, it was in the economic and financial interests of JHIL and its shareholders to implement the proposal. 143 In this regard, the matters or reasons, their characterisation as one or the other is not relevant although the former suggests a more objective exercise, that activates a decision to sell an asset to a party external to the group of companies of which the vendor forms part, will always be very different from the matters or reasons which activate the transfer of an asset to another company in the same group as part of an internal reorganisation of the group. The former will be dictated by matters of price, gain, evaluation of the asset in terms of its ongoing group contribution and temporal considerations going to the timing of the sale; the latter by reference to an evaluation of the net economic benefit to the group reorganisation that the transfer brings - on the one hand, the transfer's contribution to that benefit and on the other hand, the economic cost of that benefit. 144 What is said in [143] above, is not to introduce subjective considerations to the determination of the issue as to what might reasonably be expected to have been done if the scheme as identified had not been entered into or carried out, but they do inform the determination of that issue, put as they are without reference to the facts of this particular case. 145 So informed, the cost of implementing the proposal is obviously a relevant consideration as to whether it would be implemented in accordance with its terms. That a step in the proposal would increase the transaction costs from $35 million to $207 million, or from 2.5% of market capitalisation to 15% of market capitalisation, equivalent to what was going to be, but never was, floated on the New York Stock Exchange, compels the conclusion that if the transaction impugned as the narrower scheme or, it and the other steps which together are impugned as the wider scheme, were not entered into or carried out, the reasonable expectation is that the proposal, insofar as it involved the transfer by RCI of its shares in JHH(O) to RCI Malta would not have occurred; indeed, in our view, there is no possibility, let alone an expectation, that it that would have occurred. 146 That the transaction costs were uppermost in the minds of JHIL, its senior financial executives and external advisers, is manifest in the contemporaneous material referred to in [109], [111] and [119] above. Indeed, from as early as May 1997, transaction costs were an issue: see [49] and [50] above. This was, perhaps, best summed up by Mr Michael Brown in his evidence in chief on the Pedley paper proposal. He said at [16] of his affidavit (which went unchallenged in cross-examination): 'I recall that sometime around early 1997, I was aware that Mr Peter Pedley, a fellow JHIL non-executive director, had proposed that the Board should consider migrating the domicile and senior management of the business of the JHIL group to the United States. … I recall, having recently reviewed the paper, that I considered that the commercial reasoning underlying that paper was consistent with my own thinking and provided that Mr Pedley's ideas could be implemented efficiently and effectively, I was cautiously supportive of the concept of moving the domicile of the business of the JHIL group to the United States. My concerns were focussed on whether the costs of implementing such a proposal would be in fact outweighed by its on-going benefits. Although one of the desirable benefits would be to reduce the effective tax rate paid by shareholders of JHIL on the profits earned by JHIL, my main concern was whether such an action would deliver long-term growth prospects for the JHIL group rather than just achieve more corporate complexity and result in the incurrence of significant transaction costs. …' 147 It is clear that the anticipated transaction costs of $35 million infected the decision to proceed with the proposal. Yet, even at the end, when the matter was going to shareholders for approval, the quoted figure was expressed to be 'high' - 2.5% of market capitalisation' - but discounted as 'one-off items, whereas the financial benefits will accrue from the first year and may continue to grow' (emphasis added). The JHIL board was very conscious of these costs as is exemplified in the statement that they had 'exercised great care to ensure that the costs are no higher than they need to be'. 148 Moreover, the $35 million projected transaction costs of the proposal that went to shareholders for approval did not have to include any amount on account of the income tax ($16.55 million) in respect of the gain ($45.97 million) actually derived by RCI on the sale of the shares in JHH(O) to RCI Malta because that gain was 'sheltered' by capital losses and carry forward revenue losses. On the other hand, the additional gain under the Commissioner's counterfactual gives rise to an actual liability in excess of $172.1 million. 149 The Commissioner submitted that the economic and financial benefits for JHIL and its shareholders outlined in the Information Memorandum as accruing in the longer term were far more significant and valuable than an up-front tax cost of even $172 million and that such a cost was not an impediment to a conclusion that it is a reasonable expectation that the proposal, insofar as it involved the transfer by RCI of its shares in JHH(O) to RCI Malta, would nevertheless have proceeded despite that cost. We reject the submission. First, there was no certainty, indeed a great deal of uncertainty, that such benefits would accrue in the longer term. Even in the Chairman's address to shareholders extracted in [119] above, such financial benefits were qualified in terms that they 'may continue to grow'. Moreover, as events transpired, the volatility of the markets at the time led to the ultimate abandonment of the float of 15% of the shares in JHNV on the New York Stock Exchange. The loss in the value of longer term benefits from this abandonment is impossible to measure, but undoubtedly they would be significant because the US listing was seen as giving impetus to the value of JHNV stock over JHIL stock through the higher price earnings multiples attaching to US listings over those in Australia. And this brings us to the second reason for rejecting the Commissioner's submission, namely, there was no evidence to support the submission in the way of a valuation of these benefits having regard to the contingencies, and consequential uncertainties, upon which the assertions in the Information Memorandum were predicated; on the other hand, the additional $172 million tax cost was absolutely certain. 150 For the foregoing reasons, in our view, if the scheme in either of its manifestations had not been entered into or carried out, the reasonable expectation is that the relevant parties would have either abandoned the proposal, indefinitely deferred it, altered it so that it did not involve the transfer by RCI of its shares in JHH(O) to RCI Malta or pursued one or more of the other alternatives referred to in the Information Memorandum; but they would not have proceeded to have RCI transfer its shares in JHH(O) to RCI Malta at a tax cost of $172 million. On this view, RCI did not obtain the tax benefit it was alleged by the Commissioner to have obtained in connection with the scheme. Did JHIL, JHH(O) or RCI enter into or carry out the scheme for the dominant purpose of enabling RCI to obtain the tax benefit? 151 Having found that RCI did not obtain the tax benefit it was alleged by the Commissioner to have obtained in connection with the scheme, it is strictly unnecessary to consider the s 177D(b) issue; the appeal will be upheld. However, in deference to the primary judge's reasons and to the submissions on the hearing of the appeal, we propose to address the s 177D(b) issue on the basis, as her Honour found, that RCI did obtain the tax benefit it was alleged by the Commissioner to have obtained in connection with the scheme. Primary Judge 152 Turning first to the primary judge's reasons. 153 At [93], her Honour says: 'The evidence in this proceeding is replete with statements of the purpose of the various transactions or aspects of them, made by persons involved with those transactions. Those statements reflect the subjective intention or understanding of the makers. Such statements are of little if any assistance in determining the dominant (objective) purpose of the transactions.' 154 Again, this is not the statutory question; the statutory question goes to the purpose of a party who/which entered into or carried out the scheme, or part of the scheme, not the purpose of the scheme. This is a replication of the same error made at [22] of her Honour's reasons (see [41] above). 155 At [94], her Honour says: 'The Commissioner submitted that in the present case the purposes of Messrs Clemens and Sheppard, objectively determined, can be attributed to "each of the entities who entered into and carried out the scheme, namely JHIL, RCI and JHH(O) together with their respective officers". In principle I accept the proposition; its application is a matter for further consideration.' 156 As far as we can discern, apart from her Honour's ultimate finding at [117], her Honour did not further consider this issue. On the other hand, we too accept the proposition, but only if the adviser is a party to the scheme. 157 From [96] to [116], her Honour considers the matters in s 177D(b)(i) to (iv) separately, and (v) to (viii) together. At [117] her Honour concludes that, having regard to these matters, JHIL, JHH(O) and RCI entered into or carried out the scheme, in either of its manifestations, 'with the dominant purpose of enabling RCI to obtain a tax benefit in connection with the schemes'. Nothing turns on her Honour's use of the word 'with', rather than the word 'for'. 158 At [97] of her reasons, her Honour says: 'RCI submits that the dividend was paid to increase debt in the US and income in Australia thus generating income in Australia to enable fully franked dividends to be paid and to assist in recognising the Australian tax losses as an FITB asset in JHIL's consolidated accounts. It further submitted that the payment of the dividend in March 1998 had the same motivation as the dividend payment made in 1997, namely to reduce the withholding tax payable in the United States. This was possible because in the United States only that part of a dividend that is paid out of earnings and profit is subject to US withholding tax. Thus, in the case of the dividend of $318 million paid on 31 March 1998, only the $20 million paid in cash was subject to withholding tax. The balance, which was paid out of asset revaluation and borrowed from JHIL (secured by PN1), did not, for that reason, attract withholding tax.' 159 This was not how RCI put its submission on the s 177D(b) issue on appeal. On the hearing of the appeal, RCI submitted that the Court should conclude that, having regard to the eight matters in s 177D(b), either individually or on a global assessment (see Federal Commissioner of Taxation v Consolidated Press Holdings Ltd (2001) 207 CLR 235 at [94]), the dominant purpose of JHIL, RCI and JHH(O) in entering into or carrying out any scheme which consisted of, or included, the payment of the March 1998 dividend, was to achieve the following benefits: (1) the detachment of JHH(O) profits of US$318 million, which became an asset of RCI; (2) the dividend of US$318 million was wholly exempt from Australian tax; (3) minimum US withholding tax (US$2.39 million); (4) an increase in interest-bearing debt in the US, generating deductions in the US; (5) an increase in assessable income in Australia, which was sheltered by available tax losses; and (6) the ability to continue to recognise the substantial FITB asset in the accounts of JHIL, and the other side of that coin, namely, avoiding a write down that would reduce JHIL profits. None of these benefits, RCI pointed out, were dependent on the implementation of Project Chelsea and all of them effectively accrued to RCI and other companies comprising the Group immediately upon payment of the dividend. 160 RCI further pointed out that at the time of payment of the dividend the JHIL board had not even considered the implementation of Project Chelsea, let alone approved a proposal to go to shareholders; that the actual transfer of shares in JHH(O) from RCI to RCI Malta did not take place until 15 October 1998, one day before JHIL shareholders approved the offering and listing of 15% of JHNV on the New York Stock Exchange. Commissioner's Submissions on Appeal 161 Unsurprisingly, the Commissioner's submissions on the s 177D(b) issue on appeal embraced and supported the reasoning and conclusion of the primary judge. Reference was made, as was by her Honour below (at [99] to [103]), to the fact that the dividend was paid out of unrealised capital profits supported by a revaluation of JHH(O)'s holding in JHH(I) and that there were certain aspects of this revaluation, under the head of (i) the manner in which the scheme was carried out, which 'strongly suggests a purpose beyond that advanced by RCI' (at [102]). But 'what purpose' it may, rhetorically, be asked? The answer perhaps comes in the next paragraph of her Honour's reasons at [103]: '[T]hat the board of JHH(O) was merely playing its part in carrying out a step in the larger plan, being Project Chelsea'. The difficulty with this is that while Project Chelsea was in contemplation, its implementation was not even 'on the starting blocks'. In any event, Project Chelsea was not a matter for the board of JHH(O), but the board of JHIL. The only inference that can be drawn is that it was, on the Commissioner's case and that adopted by her Honour below, the first step taken in the implementation of Project Chelsea. If that is the correct inference to draw, then it must be accepted that it was taken whether or not Project Chelsea went forward and that, in itself, suggests that those that took the step did not do so for the dominant purpose of obtaining a tax benefit in the form of a diminution in a gain that would only be realised if the transfer by RCI to RCI Malta of the shares in JHH(O) took place. 162 At [104], her Honour observes that Project Chelsea required that RCI be divested of its shares in JHH(O). For present purposes, so much may be accepted, although RCI disputes this, claiming that it was only necessary for the 'enhancements' that came aboard Project Chelsea in February 1998 (see [47] ff above). 163 At [104], her Honour also refers to documents referring to a stock dividend being contemplated in the context of achieving 'a step-up in basis for Australian capital gains tax purposes' (see [65] above, step 5) and observes that 'there is no evidence of why that proposal was replaced by the proposal for a cash dividend'. With respect, we would have thought it is self-evident. A stock dividend would not increase interest-bearing debt in the US, generating deductions in the US, nor increase assessable income in Australia, sheltered by available tax losses, two of the benefits, said by RCI, sought to be achieved by the March 1998 dividend. 164 At [105], her Honour refers to the Commissioner's rejection of RCI's submission that the payment of the 31 March 1998 dividend was carried out in a similar way to the dividend in 1997 and that it was not contended that the 1997 dividend was paid other than for commercial purposes. Her Honour says: 'The Commissioner rejects this proposition, pointing out that, among other differences, the 1997 dividend was borrowed from external lenders and paid in cash that could be held on deposit in Australia and the interest so generated used to absorb losses carried forward. He also notes that in 1997 a dividend of $100 million was rejected as excessive whereas one year later a dividend of $318 million was declared. These differences, and others identified by the Commissioner, are sufficient to indicate that the 1997 dividend and that of 1998 were motivated by different concerns.' Subject to what we have to say below concerning the size of the dividend in the 1998 year, we are unable, with respect, to agree with her Honour's conclusion that the 1997 dividend and that of 1998 were motivated by different concerns. 165 As to matter (ii) - the form and substance of the scheme - to our minds, they are the same. It is incorrect, with respect, to say that the substance of the transaction was that a significant amount of capital was repatriated to Australia from the United States. What was repatriated was unrealised capital profits; and Mr Edwards' evidence, which her Honour accepted, made it abundantly clear that that was lawful. 166 As to matter (iii) - time - her Honour says that while it is true that there was no formal approval of Project Chelsea at the time of the revaluation and payment of the dividend, it does not follow that there was no commitment to it. We are not sure that we understand what her Honour intends to convey by the use of the word 'commitment'. None of the relevant parties had any commitment to Project Chelsea or any aspect of it, even after it received shareholder approval on 16 October 1998, prior to the particular aspect being taken. The transfer by RCI to RCI Malta of the JHH(O) shares did not take place until 15 October 1998. 167 As to matter (iv) - the result achieved but for Pt IVA - this is self-evident, namely, the tax consequence as returned by RCI. 168 As to the matters in (v) to (viii) inclusive - these provide little to no assistance in the determination of the s 177D(b) issue in the present case. 169 In our view, the only objective indicia that arguably suggests that the Court should come to a conclusion that the relevant parties - JHIL, RCI and JHH(O) - had, as their dominant purpose in entering into or carrying out the scheme - consisting of or including the payment of the 31 March 1998 dividend - the obtaining of a tax benefit, namely, a reduction in the gain that would be realised on the transfer of the JHH(O) shares from RCI to RCI Malta, is the size of the dividend: $318 million. It is a substantial sum of money and is considerably greater than the dividend paid in the previous year. Indeed, it is so much greater that its payment could not be funded from external sources lest such borrowing breached borrowing constraints to which the Group was subject from its lenders; and it ultimately led to problems with US tax rules relating to 'earnings stripping' giving rise to a need to recapitalise. Without explication, it may lead to the same conclusion to which the primary judge came. However, it is totally explicable on the basis for which RCI contends and, on its own, is not sufficient to persuade us that her Honour's conclusion on the s 177D(b) issue is correct. 170 It follows, in our view, that if this issue were relevant to the outcome of the appeal, and we had to decide this issue, we would decide it differently from the conclusion to which her Honour came. 171 The appeal must be allowed. The Commissioner must pay RCI's costs of the appeal and of the proceedings before her Honour below. I certify that the preceding one hundred and seventy-one (171) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justices Edmonds, Gilmour and Logan.
RCI Pty Limited
Commissioner of Taxation
[2011] HCA 63
(1991) 22 NSWLR 389
(2001) 207 CLR 235
(2004) 217 CLR 216
(1994) 181 CLR 359
(2010) 189 FCR 204
(2010) 186 FCR 410
(1959) 101 CLR 298
(2008) 168 FCR 149