Spassked Pty Ltd v Commissioner of Taxation

NEGOTIATIONS WITH AUSTRALIAN TAXATION OFFICE.......................... [126]-[132] LIQUIDATION PROJECT.................................................................................. [133]-[136] DIVIDENDS PAYABLE................................................................................................. [137] AGREEMENTS FOR THE PURPOSES OF s 80G OF THE ACT................................ [138] REASONING.................................................................................................... [139]-[246] COMPETENCY.................................................................................................. [139]-[157] SUBSECTION 51(1)........................................................................................... [158]-[245] General legal principles............................................................................. [158]-[192] General................................................................................................... [158]-[159] Deductibility of interest on money borrowed......................................... [160]-[162] Expectation or purpose.......................................................................... [163]-[169] Holding companies................................................................................. [170]-[180] Subjective and objective expectations and purposes............................. [181]-[186] Tax considerations as a motive.............................................................. [187]-[190] Magna Alloys..................................................................................................... [191] Steele................................................................................................................. [192] The facts..................................................................................................... [193]-[245] Spassked's general course of borrowing from IEF................................ [193]-[194] Four general matters.............................................................................. [195]-[198] Particular circumstances.................................................................................. [199] The question of expectation (in the positive sense explained at [164]-[166]) or purpose to be determined as at mid 1987 to 28 June 1990..................................................................................................... [200] Testimony of Daniels and Cottam.......................................................... [201]-[236] Summary................................................................................................. [237]-[245] PART IVA ISSUES........................................................................................................ [246] CONCLUSION.................................................................................................. [247]-[249] ANNEXURE "A" Diagram illustrating Spassked Restructuring....................................... [41] ANNEXURE "B" Diagrams illustrating eleven transactions.......................................... [105] ANNEXURE "C" Table of investments made by GIH in Subcos ................................. [111]

IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY N 1362 OF 1999

BETWEEN: SPASSKED PTY LIMITED (ACN 003 255 847)

AND: COMMISSIONER OF TAXATION

IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY N 1363 OF 1999

BETWEEN: STANLEY PARK LIMITED (ACN 008 432 997)

AND: COMMISSIONER OF TAXATION

IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY N 1364 OF 1999

BETWEEN: INDUSTRIAL EQUITY LIMITED (ACN 004 617 164)

AND: COMMISSIONER OF TAXATION

introduction 1 These three proceedings involve appeals by taxpayers against what the applicants contend are appealable objection decisions under s 14ZZ of the Taxation Administration Act 1953 (Cth) ("the Administration Act"). The objection decisions were decisions by the respondent Commissioner ("the Commissioner") to disallow objections by the applicants dated 9 May 1997 to their respective assessments of income tax, notices of which were issued on 14 March 1997 for the year ended 30 June 1992 ("the 1992 year of income" and "the 1992 year"). 2 As explained below, three amounts totalling $932,667,411 were claimed by the three applicants as allowable deductions against their assessable incomes for that year. But I was informed that similar circumstances also prevailed in each of the six years ended 30 June 1988, 1989, 1990, 1991, 1993 and 1994. Apparently the total amount of the deductions claimed in respect of all seven years by all companies which the Commissioner has disallowed and which involve the issues that arise for decision in these proceedings, is $6,527,082,709. 3 The applicant in proceeding N 1362 of 1999, Spassked Pty Limited ("Spassked") and the applicant in proceeding N 1363 of 1999, Stanley Park Limited ("SPL"), were, at material times, wholly owned subsidiaries of the applicant in proceeding N 1364 of 1999, Industrial Equity Limited ("IEL"). Nearly all of the other companies to which I will have occasion to refer were also wholly owned subsidiaries of IEL, and therefore part of "the IEL Group" (or "the Group"). 4 For the 1992 year Spassked returned a loss of $873,511,525. By his notice of assessment issued on 14 March 1997, the Commissioner disallowed a deduction claimed by Spassked for interest paid by it to IEL Finance Limited ("IEF") of $888,165,526, resulting in an adjusted taxable income of $14,654,001. According to the notice of assessment, Spassked was assessed to tax on this amount in a sum of $5,715,060.39, but after allowing for a credit of $5,715,060.39, the balance of the assessment, and the amount payable, were both "$0.00". 5 There were two grounds on which the Commissioner disallowed Spassked's claim to deduct the interest of $888,165,526 paid to IEF. The first was that it was not deductible under either of the two positive limbs of subs 51(1) of the Income Tax Assessment Act 1936 (Cth) ("the Act"). Whether it was so deductible is the first major issue in the case. The second ground was that if it was so deductible, the Commissioner had made a determination on 10 March 1997 for the purposes of par 177F(1)(b) of the Act that the whole of the interest should not be an allowable deduction. Whether the Commissioner's purported determination under par 177F(1)(b) was effective is the second major issue in the case. 6 The issues which arose in the SPL and IEL proceedings were consequential on those in the Spassked proceeding. On the basis that Spassked was entitled to an allowable deduction of $888,165,526 in respect of the interest paid to IEF, and therefore sustained the loss of $873,511,525, it transferred a loss of $109,360 to SPL and a loss of $44,392,525 to IEL pursuant to subs 80G(6) of the Act (see [33] below). But since, in accordance with the Commissioner's assessment of Spassked, those amounts of loss had not been incurred by Spassked, they were not available to be transferred by it. Therefore, the Commissioner disallowed in his assessments in respect of SPL and IEL the amounts of the losses claimed by them as deductions. In the case of SPL, this had the effect that its taxable income for the 1992 year as returned of $88,605,000 was increased by $109,360 to $88,714,360. In the case of IEL, it had the effect that its taxable income for the 1992 year as returned of $225,266,618 was increased by $44,392,525 to $269,659,143. On 12 March 1997 the Commissioner made determinations under par 177F(1)(b) of the Act in respect of SPL and IEL. 7 The grounds of disallowance in the case of each of SPL and IEL were also two: first, that in terms of subs 80G(6) of the Act, the claimed loss purportedly transferred to the taxpayer was not an allowable deduction; and, secondly, that if it was, the Commissioner had made a determination on 12 March 1997 for the purposes of par 177F(1)(b) of the Act that the loss transferred should not be an allowable deduction. These two grounds gave rise to two issues in each of the SPL and IEL proceedings, which mirrored those in the Spassked proceeding referred to above. 8 Determination of the two issues in the Spassked proceeding will determine those in the SPL and IEL proceedings. For this reason, I will later generally find it convenient to refer to Spassked as if its appeal were the only one before the Court. 9 On 9 May 1997 each of Spassked, SPL and IEL gave notice of objection against its assessment. On 19 November 1999 the Commissioner gave each of them a "notice of decision on objection" indicating that its objection had been disallowed. 10 All three of the present proceedings were commenced on 22 November 1999. 11 There is a further issue in the Spassked proceeding. The Commissioner contends that Spassked's appeal is not properly constituted because there was no "objection decision". This contention, which has no application in the SPL and IEL proceedings, arises from the fact that the assessment in respect of Spassked was a "nil" assessment.

general background facts 12 IEL was incorporated pursuant to the Companies (Victoria) Code 1961 on 11 November 1964. In June 1966 a majority shareholding in IEL was acquired by a company associated with Mr Ronald Brierley ("Brierley" - later Sir Ronald Brierley) who became chairman of IEL immediately following the takeover. Brierley remained chairman until 1990. Since at least 1973, IEL's investment policy followed Brierley's policy of "expansion by acquisition": the acquisition of companies thought to be undervalued by the market relative to the value of their underlying assets and business operations, followed by the taking of steps to realise that value. 13 This policy proved to be successful and the IEL Group expanded. Over the years of income 1974 to 1987, IEL's consolidated net profits after tax grew from approximately $1.1 million to approximately $230 million, the number of subsidiary companies IEL controlled expanded from 117 to 591, and the number of employees of the Group rose from approximately 850 to approximately 23,000 people. 14 The IEL Group was managed by a small number of executives and staff who were encouraged by Brierley to deal with each other on a face to face basis and who were discouraged from generating what Brierley perceived to be unnecessary paper work. Accordingly, despite the growth in size and earnings of the Group during the period of fifteen years down to 1987, the approximate number of head office staff (including administrative staff) increased from only sixteen to only thirty people. 15 From about 1983 the management of the Group was divided into two main areas. The first concerned the acquisition, management and disposal of its investments. This was under the control of an "Investment Team". The other concerned the implementation of decisions of the Investment Team, as well as the day to day administrative and regulatory affairs of the Group. This area was under the control of an "Administration Team". The Investment Team and the Administration Team held informal daily meetings. 16 In about 1978 IEL ceased acquiring investments in its own name. Instead, its subsidiary companies commenced doing so. 17 The IEL Group borrowed from external sources to fund its acquisitions. In 1985 IEF commenced acting as the in-house finance company for the Group. By that time the use of an in-house finance company had become a common feature of the corporate group business scene because of the savings and benefits associated with the centralisation of funds management within one entity. 18 For a short time IEF lent to and borrowed from other IEL subsidiaries at rates which enabled it to recover its own costs. Later, however, it increased the interest rates it charged to other Group companies so that it obtained a slight margin on its activities. 19 By late 1986 the shareholding and debt lines within the IEL Group were complex, even when compared to those of other large corporate groups operating in Australia at the time. The complexity arose in part because of a policy adopted as from 1978 (referred to in [16] above) that any new investment should be acquired by a specific subsidiary dedicated to the purpose. This led to a proliferation of subsidiaries. Moreover, in some cases pre-existing complex structures had been "inherited" as a result of takeovers. 20 I will discuss below the purposes and effect of the adoption in late 1987 of a new structure in which Spassked was centrally involved (respectively, "the Spassked Restructuring" and "the Spassked Structure"). Briefly, it was a matter for concern at that time that there were "dividend traps" within the Group, arising from the fact that intermediate holding companies had expenses (in particular, interest on their borrowings) against which any dividends received by them had to be applied before the amount of any profit or loss could be determined. This had two potentially damaging consequences for the Group: first, it prevented the free flow of dividends up to the ultimate holding company, IEL, and to its shareholders; secondly, if the taxable income of the recipient company was less than the amount of the dividend it received (by reason, for example, of the size of current interest expenses or losses carried forward from past years), part or all of the intercorporate dividend rebate otherwise available under s 46 of the Act in respect of the dividends would be lost. The dividends would be trapped, and any associated s 46 rebate foregone, in the recipient company. 21 The applicants submit that there were four purposes of the adoption of the Spassked Structure (the second and third are related): · the simplification of the Group's corporate debt and equity lines; · the avoidance of the dividend traps described; · the avoidance of the foregoing of s 46 tax rebates; and · the ready availability, as vehicles through which new acquisitions could be made, of a range of subsidiary companies with various levels of paid up capital. 22 The Commissioner, on the other hand, contends that the purposes of the adoption of the Spassked Structure were the related ones of eliminating dividend traps (and the associated foregoing of s 46 rebates) and exploiting to maximum advantage the possibility of transferring losses, by centring interest expenses, and therefore losses, in a corporate vehicle dedicated to that purpose (Spassked), from which the losses could be transferred to other members of the IEL Group, as seemed, to those in control, in the interests of the Group as a whole from a tax viewpoint. 23 The Spassked Structure was put in place in late December 1987 and was used in a series of transactions from then to June 1990. 24 On or about 20 November 1989 ownership and control of the IEL Group passed to a group of three companies: The Adelaide Steamship Company Ltd, David Jones Ltd and Tooth & Co Ltd (collectively, "the Adsteam Group"). Each of these companies held a one third shareholding in various subsidiaries, one of which was Dextran Pty Ltd ("Dextran"). It was Dextran which acquired all the issued shares in IEL. 25 Following the takeover by the Adsteam Group, in February 1990 Mr Spalvins of the Adsteam Group replaced Brierley as chairman of IEL. On or about 18 June 1990 shares in IEL were suspended from official quotation on the Australian Stock Exchange ("ASX"). 26 By as early as about November 1990, the Adsteam Group was experiencing difficulties in meeting its debt commitments. On or about 4 November 1990, the Adsteam Group and IEL announced to the ASX that an "in principle" agreement had been reached with the bankers to the Adsteam Group on a comprehensive program of restructuring and rationalising the Group's financial and capital base. Over the 1992 to 1997 financial years Dextran borrowed from IEL amounts totalling $2,037,702,786. In sum, from about November 1990, the IEL Group was in de facto administration and there was little or no chance of its continuing as a going concern. 27 In 1994 the Spassked Structure was "wound up" when Spassked borrowed from GIH, and to a small extent from IEL, in both cases interest free, and used the borrowed funds to pay out its debt to IEF in full, that is to say, to pay both the capital sums it had borrowed from IEF and the capitalised interest on its borrowings. From that time, GIH was Spassked's creditor in place of IEF, but, unlike IEF, was not charging Spassked interest. 28 The parties having an interest, in practical terms, in the outcome of the three proceedings are certain banks as creditors of the members of the Adsteam Group, and, of course, the Commissioner.

the spassked structure 29 In order to understand the rationale and effect of the Spassked Structure, it is necessary to understand the legislative and factual background to its adoption in the latter half of 1987.

Franked and unfranked dividends 30 "Dividend imputation" was introduced on 1 July 1987 and so was first applicable in the tax year ended 30 June 1988. It was intended to give shareholders who were natural persons and who received a dividend, a credit for any tax which had been previously paid on the dividend by the company. Under the new régime a dividend would carry or not carry the benefit of such a credit, according to whether tax had or had not been paid on the dividend before it was received by the individual. A dividend that carried that benefit was "franked" and a dividend that did not carry it was "unfranked". Clearly, as between two dividends of the same amount, an individual would prefer to receive a franked dividend because he or she would be entitled to a rebate off his or her own tax liability to the extent of the franking credit attached to the dividend. A franking credit could be passed up through a line of companies through the ultimate holding company to its natural person shareholders.

Section 46 "dividend rebates" 31 Section 46 of the Act provided for a full rebate of the amount of tax which would otherwise be payable on a dividend paid by one resident public company to another resident public company. (IEL and its subsidiaries were resident public companies - see s 46(2)(b); subs 6(1) (definition of "private company"); subss 103A(1), 103A(2)(a) and 103A(2)(d)(v).) Prior to the introduction of imputation, subs 46(7) had the effect that the amount of the rebate was reduced by reason of a requirement that for the purpose of calculation of the amount of the rebate, there be set off against the amount of the dividend the amount of any interest expense directly referable to it. But following the introduction of imputation, the set off no longer applied. Accordingly, for the year ended 30 June 1988, the amount of the rebate was simply the amount of the tax payable on the dividend received. 32 What is of immediate importance is that the "rebate" was of an amount of tax that would have been payable by the recipient of the dividend on the amount of the dividend. Accordingly, for the rebate to operate, there had to be tax payable by the recipient of the dividend, and the amount of the rebate could not exceed the amount of that tax. If the dividend recipient's allowable deductions exceeded its assessable income (including the dividend), it would have no taxable income and so there would be no tax payable against which any rebate could operate. In that situation the benefit of the tax rebate made available by s 46 would be foregone.

Tax losses 33 The Act's provisions for the deductibility of losses were complex. All that need be said for present purposes is that, in general terms and omitting qualifications: a taxpayer incurred a loss for tax purposes when its allowable deductions exceeded its assessable income and net exempt income (subs 80(1)); losses incurred in any of the seven years next preceding the year of income could be "carried forward" in the sense that they were "allowable deductions" in the year of income (subs 80(2)); and as between resident companies in a group, such as the IEL Group, losses could be transferred by a "loss company" in the group to an "income company" in the group, so that the loss was deemed to have been incurred by the income company (subs 80G(6)). It was necessary that, but for the transferred loss, the income company have a taxable income. Transfer was effected under subs 80G(6) by an agreement which was required to be in writing: subs 80G(6A).

Dividend traps 34 As noted earlier, prior to the Spassked Restructuring there were dividend traps within the IEL Group. Assume a subsidiary company whose only income was in the form of dividends and whose outgoings for interest on borrowings exceeded the amount of those dividends. The subsidiary would have no current year's profit from which it could pay a dividend. Unlike s 46 dividend rebates and "tax losses", this was a matter of company law rather than tax law. Section 565 of the Companies Code and its successor s 201 of the Corporations Law prohibited payment of dividends except out of profits. Accordingly, a company which had made a loss rather than a profit could not, in effect, "stream" or "pass" up the line any dividends it received from companies below it (or, therefore, any franking credits attached to such dividends). Not only would a dividend received by the company and any franking credit attached to it be "trapped" within the company: the company would not be entitled to a s 46 rebate. The reason is that it would have no taxable income and so there would be no amount of tax to be rebated. 35 Being unable to take advantage of the s 46 rebate did not matter to the dividend trap company itself, because either way its taxable income was nil. But it mattered to the Group as a whole. The Group was worse off than it would have been if the interest expense had been incurred by another Group member which was not a recipient of the dividend income. In that case the company which received the dividend would have a taxable income and so be in a position to take advantage of the s 46 rebate. As well, it would be in a position to pay a dividend and so to pass up the line any franking credit attached to any dividend which it had received. Moreover, the interest incurring member of the Group would make losses which it could transfer to such other members of the Group, as might be in the interests of the Group, to form deductions against their assessable income. 36 In sum, dividend traps could be avoided and the benefits of s 46 rebates and of the carry forward loss and group loss transfer provisions could be obtained, if the incurring of the expenses and the receipt of dividends were separated so that they took place in different companies.

Company law and tax law treatment of losses 37 As noted above, s 565 of the Companies Code and its successor s 201 of the Corporations Law prohibited the payment of dividends except out of profits (the current section is s 254T of the Corporations Act 2002 (Cth)). The Australian legislation has not defined "profits" for this purpose, leaving the matter to the general law and the evidence of accountants and others as to commercial practice. Although sound accounting practice may be otherwise, past years' losses are not required by law to be made good before it can be said that there is a current year's profit distributable by way of dividend: Ammonia Soda Co Ltd v Chamberlain [1918] 1 Ch 266; Marra Developments Ltd v BW Rofe Pty Ltd [1977] 2 NSWLR 616 at 630. A fortiori, a transferee under s 80G of the Act of losses within a group was not required to deduct them in determining whether it had such a current year's distributable profit. 38 Thus, while Spassked was required by law to deduct the interest which accrued due to IEF in the year of income in order to determine whether it had a distributable profit for that year, it was not required to deduct past years' losses for that purpose. But for tax purposes it was required to deduct past years' losses in determining whether it had a taxable income for the year ("taxable income" was defined in subs 6(1) as, relevantly, "the amount remaining after deducting from the assessable income all allowable deductions"). Similarly, if Spassked transferred an amount of loss to another company in the Group, the transferee likewise would not have to deduct that amount in order to determine if it had a distributable profit for the current year, but for tax purposes it would be required to deduct the amount in order to determine if it had a taxable income for that year.

The changes made by the Spassked Restructuring 39 The following is a simplified and general account of the changes made by the Spassked Restructuring. Previously, direct subsidiaries of IEL were the Group's investment vehicles, making investments and borrowing for that purpose from the Group's in-house banker or financier, IEF. Under the Spassked Structure, two subsidiaries of IEL, Spassked and Group Investment Holdings Pty Ltd ("GIH"), were interposed between both IEL and IEF on the one hand and the investing subsidiary ("Subco") on the other. Spassked and GIH were both incorporated in New South Wales on 17 March 1987 (Spassked and GIH having had different names at first, to which I need not refer further). Spassked was to be the borrowing member of the Group; GIH was to be an intermediate parent company in the Group. 40 IEL owned all the issued shares in Spassked (and in IEF). IEL and Spassked owned the issued shares in GIH as follows: (a) Spassked held A Class shares ("A" shares) which entitled it to franked and unfranked dividends, full voting rights and participation in any surplus on a winding up; (b) IEL held B Class ("B" shares) shares which entitled it to franked dividends only, limited voting rights and no right to participate in any surplus on a winding up. 41 The diagrams attached as Annexure "A", based on diagrams provided by the Commissioner, show, in simplified form, the respective positions before and under the Spassked Structure. 42 As can be seen, both before and under the Spassked Structure, IEF borrowed externally and "on-lent" to a member of the Group at a higher rate of interest. But pre-Spassked, it was the direct subsidiary of IEL which borrowed from IEF and made the underlying investment, whereas under the Spassked Structure, Spassked borrowed from IEF and used the money borrowed to subscribe for "A" shares in GIH, which, in turn, subscribed for shares in the Subco, which, in turn, made the underlying investment in, commonly, shares in listed public companies. 43 The company designated "Subsidiary" in the pre-Spassked diagram is a dividend trap because it has borrowed from IEF and is accruing interest to IEF equal to or exceeding the amount of the dividend it received: the whole of the dividend is trapped in the Subsidiary and cannot be passed upstream. But in the post-Spassked diagram this is no longer the case: the investing subsidiary is able to pass up the dividend it receives to GIH which also has not borrowed at interest from IEF. There is the possibility of GIH paying a dividend because it has made a profit. And if the dividend it has received is franked, it can pass on the franking credit. Finally, post-Spassked, advantage can be taken of the s 46 rebate because both the Subco and GIH do incur a tax liability on, if nothing else, the dividends they have received. In the simple case where their only income is a franked dividend, they can, in effect, "transmit" that dividend with the franking credit upwards, in the case of the Subco to GIH and in the case of GIH to IEL (or, but for the dividend trap problem, to Spassked) without having had to pay tax on it because of the s 46 rebate. 44 The applicants contend that the Spassked Structure was "tax neutral" because the interest claimed as a deduction by Spassked was shown as assessable income in the hands of IEF, and, the applicants submit, if it had not been, IEF would have suffered losses which it, rather than Spassked, could have transferred to other members of the Group. But the Commissioner replies that for the purposes of the Group as a whole, the Spassked Structure was not tax neutral and was very "tax beneficial" to the Group.

the respective parties' statements of facts, issues and contentions 45 From 30 December 1987 to 28 June 1990, that is, in the three years of income 1988, 1989 and 1990, IEF provided Spassked with financial accommodation in amounts totalling $3,737,142,866 (see [100] below). The financial accommodation was not: · provided under any written agreement between IEF and Spassked; · recorded in any minutes of either IEF or Spassked; or · the subject of any formal resolutions of the board of directors of either IEF or Spassked. 46 Spassked's decisions to subscribe for shares in, or lend money to, GIH, and GIH's decisions to allot shares to, or borrow money from, Spassked were not: · recorded in any minutes of either Spassked or GIH; or · the subject of any formal resolutions of the board of directors of either Spassked or GIH. 47 The amounts of interest payable by Spassked to IEF on the financial accommodation provided by IEF to Spassked were capitalised every six months in the books of account, by being added to the balances owing by Spassked to IEF. They totalled $3,272,715,111 for the seven years of income down to the time when Spassked's indebtedness to IEF was discharged (see [107] below for the individual amounts). 48 In the period from 1 July 1987 to 30 June 1994: (a) the Subcos received "rebateable dividends" from their investments in listed and unlisted company shares; (b) Spassked received only a small fraction of those dividends. In fact, in that period, according to the financial records of Spassked and GIH, Spassked was paid only the following two dividends (both unfranked) by GIH: For year ended Amount ($) 30 June 1990 29,308,093 30 June 1992 14,654,046 -------------- Total 43,962,139 ========

(For the year ended 30 June 1990, Spassked was also paid a franked dividend of $182,079 by GIH, making a total of the dividends paid to it for that year of $29,490,172, and an overall total of $44,144,218, but later records show a "correction" to exclude that amount and to credit it to IEL. I shall proceed on the basis of the corrected position.) In the same period, IEL received $33,378,828 in franked dividends from GIH, representing, but for a $3.00 discrepancy (which I will henceforth ignore), all the franked dividends GIH had received from its Subcos in that period. 49 In the same seven year period, as a result of its liability to IEF for interest, Spassked incurred losses which it purported to transfer to other members of the IEL Group pursuant to s 80G of the Act. By 1998 Spassked had transferred all its losses. 50 The Commissioner points to the disproportion between Spassked's interest expenses to IEF of $3,272,715,111 over the seven year period and the dividends it derived from GIH over that period of only $43,962,139, and submits that Spassked was, and was always intended to be, a dedicated borrowing and loss making and loss distributing centre within the Group, and was not, and was never intended to be, a recipient of assessable income. 51 In his Further Amended Statement of Facts, Issues and Contentions, the Commissioner identified "the purported effect" of the series of transactions. According to the Commissioner, that purported effect was to create, or to continue, an interest expense in Spassked and to remove or offset an interest expense that would otherwise have been incurred by a Subco, or by a particular identified Subco. In the case of one transaction, the Commissioner contended, in the alternative, that "the purported effect" was to avoid the operation of subs 51(6) and/or s 79D of the Act. 52 The Commissioner contended that the amount of $888,165,526, claimed by Spassked as an allowable deduction for the 1992 year, was neither "incurred in gaining or producing the assessable income" within the first positive limb of subs 51(1) of the Act, nor "necessarily incurred in carrying on a business for the purpose of gaining or producing such income" within the second positive limb of that subsection. 53 The Commissioner contended that Spassked borrowed the funds from IEF for other purposes which are expressed in alternative ways. He contended that Spassked borrowed for the purpose of "locating" the interest outgoing in Spassked. The Commissioner's contentions continued as follows: "2. Further or in the alternative ... , the amount of $888,165,526 is not an allowable deduction under s 51(1) of the Act ... because: (a) there is a gross disproportion between the amount of the outgoings and the assessable income derived by Spassked from its investment in GIH in the 1991-92 year of income ($14,654,046); (b) further, there is a gross disproportion between the amount of the outgoings allegedly incurred by Spassked in the period from 1 July 1987 to 30 June 1994 ($3,272,715,109 [sic]) and the assessable income derived by Spassked from its investment in GIH in that period ($44,144,218 [see [48] above - $43,962,139]); (c) the gross disproportion is to be explained by the pursuit by Spassked, in the obtaining of loans and other financial accommodation from IEF and in its investments in (and loans to) GIH, of an objective other than the gaining or producing of assessable income; (d) the independent objective of incurring the interest expense was to benefit other companies in the IEL Group from whom Spassked could not derive assessable income by creating tax advantages for those companies. 3. Further or alternatively to paragraph 2(d), the independent objective of incurring the interest expense was to: (a) create an interest expense in Spassked and to remove or offset an interest expense in a Subco so that the rebate on dividends received or expected to be received by the Subco would not be reduced as a result of that company claiming allowable deductions for that interest expense; (b) ensure that non-rebateable assessable income derived by a company (other than Spassked) is reduced by interest deductions (in the form of s 80G loss transfers) which would otherwise have been reduced or offset by rebateable assessable income in some other company. 4. Further or alternatively to paragraph 2(d), the independent objective of incurring the interest expense was to: (a) create or continue an interest expense in Spassked and to remove an interest expense in [the Subco, Harbourfort Pty Ltd - called "IDE", an acronym based on its former name] so that the rebate on dividends received or expected to be received by IDE from [Woolworths Ltd - called "WLW"] would not be reduced as a result of IDE claiming allowable deductions for that interest expense; (b) ensure that non-rebateable assessable income derived by IDE is reduced by interest deductions (in the form of s 80G loss transfers) which would otherwise have been reduced or offset by rebateable assessable income. 5. Further or alternatively to paragraph 2(d), the independent objective of incurring the interest expense in respect of the loan described in paragraph 17(a) above [a reference to a loan on or about 31 March 1988 in the amount of $675,000,000 from IEF to Spassked - see [100] below] was: (a) to avoid the operation of s 51(6) of the Act; and/or (b) to avoid the operation of s 79D of the Act." 54 In relation to the issue of the effectiveness of the s 177F determination, the Commissioner's contention was as follows: "6. ... , the amount of $888,165,526 is not allowable as a deduction ... because a delegate of the Commissioner determined pursuant to s 177F of the Act that the sum was not allowable ... and the necessary conditions for the determination were satisfied as follows: (a) Spassked obtained a tax benefit in connection with the scheme by the sum of $888,165,526 being allowable as a deduction to Spassked ... where the whole or part of that sum would not have been allowable as a deduction, or might reasonably be expected not to have been allowable, ... if the scheme had not been entered into or carried out; (b) the scheme was constituted [as described in the Commissioner's document - I will not summarise the description here]; (c) having regard to the matters in s 177D(b) of the Act, it would be concluded by a reasonable person that the scheme or part of the scheme was entered into or carried out by a person for the dominant purpose of enabling Spassked to obtain the tax benefit in connection with the scheme; ..." 55 Spassked identified the issue as to the effectiveness of the s 177F determination as follows: "19. Whether the respondent made and was entitled to make a determination pursuant to s 177F(1)(b) of the Act that the whole of the amount of $888,165,526 is not allowable as a deduction to Spassked ... and in particular whether: (a) a 'scheme' within the meaning of s 177A(1) of the Act was entered into or carried out; (b) Spassked obtained a 'tax benefit' within the meaning of s 177C(1) of the Act in connection with any such scheme; (c) it would be concluded on the basis of the matters referred to in s 177D(b) of the Act that one of the persons who entered into or carried out the scheme or any part of the scheme did so for the dominant purpose of enabling Spassked to obtain that tax benefit in connection with the scheme; (d) the making of the Determination was a proper exercise of the respondent's discretion under s 177F(1) of the Act." 56 Spassked contended that the motivation or subjective object or purpose of a taxpayer is irrelevant to Part IVA and is generally irrelevant to both positive limbs of subs 51(1). In particular, Spassked contended that it is irrelevant that those concerned in the adoption of the Spassked Structure may have been motivated by tax considerations. According to Spassked, the criterion of deductibility was the objective one of whether the interest expense arose from a borrowing of money which Spassked, as a holding company, used to fund the making by GIH and the Subcos of investments which were inherently capable of generating income for Spassked. 57 In relation to the "gross disproportion" which the Commissioner said existed between the aggregate amount of interest expense Spassked incurred ($3,272,715,111) and the relatively small amount of dividend income Spassked received ($43,962,139), Spassked contended that all that mattered was whether it borrowed money for the purpose of acquiring shares capable of producing dividends. Spassked further argued that, although it had received from GIH dividends of only $43,962,139 down to 30 June 1992, in the ordinary course of events it would have received more, indeed, it would have received dividends sufficient to enable it, perhaps with a return of capital from some of the investments, to discharge its liability to IEF. But Spassked asserted that the "ordinary course of events" did not take place for two reasons. The first was the acquisition of IEL by the Adsteam Group in November 1989, followed, a year later, by the Adsteam Group's financial difficulties and the de facto administration of IEL referred to earlier. The second was the challenge or threatened challenge by the Commissioner to the deductibility of Spassked's interest expenses to IEF and of the losses purportedly transferred by Spassked to other members of the Group, and the consequential unwillingness of directors of any of the transferees to stream up dividends against the possibility that the Commissioner's stance might be sustained. 58 The Commissioner contended that, as was always intended, Spassked was not in the business of generating assessable income and was in fact only in the "business" of generating losses. The Commissioner pointed out that if Spassked had been in the business of generating assessable income in the form of a stream of dividends from GIH, those dividends would have been caught in the largest dividend trap in the Group, in view of the large amount of interest Spassked was incurring on its borrowings from IEF.

more detailed evidence of the factual background 59 Many of the facts in the case were established by a lengthy affidavit of Ross Daniels ("Daniels") who was a management accountant employed by IEL from early 1974 to June 1994, when he accepted a redundancy offer. For much of that time he was the senior management accountant of the IEL Group. After his period of employment by IEL, Daniels was retained by IEL as a consultant accountant from late 1994 down to the time of the hearing. Daniels was centrally involved in devising and implementing the Spassked Structure. Similarly involved, though to a lesser extent in some respects, was Gregory Kingston Cottam ("Cottam"), a chartered accountant, who joined the IEL head office as a "Tax Manager" in June 1987 when the devising of the Spassked Structure was already well under way, and six months before its approval in December 1987. Cottam was also called as a witness by Spassked. Much of what follows is based on their affidavits, particularly those of Daniels. 60 Daniels was at pains to establish the modus operandi of those who conducted the day to day operations of the IEL Group, and, in particular, the closeness of the individuals concerned and the informality of their procedures. For this reason, I will give a more extensive account of the evidence of the factual background than I might otherwise feel compelled to do.

The IEL Group 61 IEL was a share investment company, first incorporated as an unlisted company in 1964 in Victoria. It was acquired in 1966 by Citizens and Graziers Life Assurance Co Ltd, a wholly owned subsidiary of the New Zealand company, RA Brierley Investments Ltd. When Daniels joined IEL in early 1974 it was listed on the ASX and was a holding company of almost 120 Australian and New Zealand companies. In 1974 through its operating subsidiaries, then comprising about half the Group, IEL controlled a diverse range of operating businesses. The other half of the Group comprised mainly inactive or shelf companies held available for future investments or acquisitions. 62 Daniels was employed in IEL's head office where some fifteen other IEL officers and staff worked. The head office was always small in relation to the rapidly increasing size of the IEL Group in the 1970s and 1980s. Daniels described "the main focus of head office staff" as facilitating the acquisitions or other investments which Brierley or other members of the Investment Team wished to make. The Investment Team comprised Brierley, certain senior officers of IEL, company analysts and various other staff from time to time. The Investment Team met regularly, often on a daily basis, from 1974 until about 1990. Head office staff, including, from about 1976, Daniels, were responsible for the financing and structuring of the companies that were to be used for the investments decided upon by the Investment Team. According to Daniels, from the early 1980s, he became "principally responsible for this investment support function".

Business management/administration and planning role 63 By 1982 Daniels was one of the most senior employees of IEL, responsible for the management, planning and administration of the Group. Daniels stated: "My administration and planning role involved me in identifying which head office company or entity should be used for a particular investment or acquisition under consideration. As part of this process, I determined the most appropriate means of funding an investment company, either by debt, equity or, on occasion, some combination of both. In doing so, I had regard to shareholding, accounting, corporate, legal, administrative and financial matters. I then took all steps necessary to facilitate the funding of the investment. This included raising capital for the venture, liaising with the IEL investment manager, the investment team and, where it was a significant investment, dealing with Sir Ronald Brierley or Mr Loewenthal [who became chief executive officer of IEL in 1973] (and later also Mr Russell Goward and Mr Rodney Price who became, respectively, the chief executive officer of IEL in 1984 and 1986), to ensure the investment team's objectives were met. This aspect of my work became increasingly significant as the IEL group continued to expand." 64 From about 1985 Daniels was a director of approximately 600 IEL subsidiaries.

Head office managed companies and externally managed companies 65 In 1974 IEL held about fifty or sixty non-income producing shelf companies and other companies which had once traded but had since become inactive. Generally, the shelf companies were companies which IEL had caused to be incorporated. The companies which had formerly traded were often companies which IEL had acquired, but which had become inactive following a post takeover restructuring. Generally, both types of company were held in readiness to make takeover bids or to exploit other investment opportunities. The Investment Team's demand for such companies increased as the Group expanded through acquisitions from the mid 1970s to the late 1980s. 66 Daniels was principally responsible for IEL Group taxation matters until about 1985. He had become involved in those matters in the late 1970s. Over the succeeding years, he developed an understanding of the basic elements of Australian corporate taxation law. When he first became involved, IEL's tax affairs were "relatively straightforward" and took up only a minor part of his time. But with the rapid expansion of the Group in the late 1970s and early to mid 1980s, and the "successive waves of company tax reform in Australia and New Zealand commencing in the mid-1980s", he realised that he lacked the necessary time and expertise. 67 In about March 1984, Stephen Latham ("Latham"), a chartered accountant, became employed by IEL. He initially assisted Daniels, then gradually assumed management of the Group's tax affairs. Over the next two to three years, Latham's role broadened into one of assisting Daniels in handling some of the more complex management, accounting and planning issues, and the development of structured finance proposals. By the time Cottam joined IEL in June 1987, the Administration Team was already considering a restructuring of the Group, which became known as "the Spassked Structure". Latham and Cottam consulted with Daniels regularly on taxation maters. Latham was not called as a witness.

Dividend recommendations 68 By the mid to late 1970s, having ceased to invest directly, IEL had become almost entirely reliant for income, and therefore for the means of giving a return to its own shareholders, on receiving dividends from its subsidiaries. 69 Daniels said that in about 1976 he became involved in calculating the funds of profits available from which dividends would be paid upstream, ultimately to IEL's shareholders. He made dividend recommendations to the boards of directors of the relevant companies in the Group and to the IEL board itself. He stated that to the best of his recollection, his recommendations were accepted. 70 Cottam said that a "Review Group" comprising himself, Daniels, Latham, and a partner in the Group's external auditors, met twice each year, usually in May and in November/December, for about a week, to review trial balances and to decide upon any dividend recommendations to be made.

Administration Team meetings 71 In 1983 regular Administration Team meetings, which were usually held following the daily Investment Team meetings, were instituted. Daniels was a member of the Administration Team from its inception and attended all its meetings between 1983 and 1994, except on the few occasions when he was out of the office, or during a period of ten months in 1990 when he was overseas. To the best of his knowledge, no minutes were made recording the proceedings of the meetings, which he described as "informal get togethers and an opportunity to discuss investments and issues associated with investments". Cottam was also a member of the Administration Team.

Structural concerns 72 Paragraph 40 of Daniels' affidavit was as follows: "In late 1986 or early 1987, it became apparent to me that a restructure of the IEL group was necessary. I was concerned that the ad hoc way in which head office managed companies were selected and capitalised for investment purposes was not proving very effective or efficient, from either an administrative, planning, or economic viewpoint. It appeared to me that it was becoming increasingly difficult, because of the rapidly expanding nature of the group, to keep track of which company had made investments, and also to manage the IEL group's investment portfolio as a whole. There also appeared to me to be a need to simplify the equity and, more particularly the debt lines between IEL group companies, which had become very complex due to a range of reasons, but principally the dramatic growth of the IEL group in the period 30 June 1974 to 30 June 1987. This is illustrated by the table below (which I have prepared following a review of IEL's annual reports in this period).

IEL GROUP Indicator 30 June 1974 30 June 1984 30 June 1985 30 June 1986 30 June 1987 Consolidated net profit after tax $1.1 million $26.312 million $51.168 million $145.271 million $230.116 million Number of consolidated group companies 117 245 299 365 591 Approximate total head office staff (including administrative staff) 16 30 26 30 30 Approximate total group employees 850 15,000 16,000 23,000 23,000 … Average shareholders funds $8.9 $104.8 million $181.0 million $488.7 million $1,007.9 million million Return on average [shareholders' funds] 12.5% 25.1% 28.3% 29.7% 22.8% "

73 There were tendered in evidence three charts showing the debt lines and equity lines within the IEL Group at 30 June 1987. Daniels explained as follows in his affidavit: "One of the main reasons why equity lines had become so complex by 1987, was because of the widespread use of a different company, or entity, for each investment or acquisition that was made by the IEL group. It was also attributable to the fact that in the case of quite a number of acquisitions, a whole corporate group was acquired, complete with holding companies, intermediate holding companies and operating subsidiaries. Often, these companies had pre-existing debt or equity lines that were maintained after their acquisition by the IEL group. Once incorporated within the IEL group, ongoing finance needs were often met by sources within the IEL group, which provided such funding via debt or equity. As a result, debt and equity finance was provided or used by companies at all levels across the IEL group. In the case of debt lines, the complexity was attributable to similar historical factors. It was also attributable to attempts by myself and other members of the administration team to 'match' the companies which had acquired or were about to acquire assets likely to produce assessable income with the companies which had initially raised funds for the investment through external or inter-company loans. This was done for administrative and accounting reasons. By doing this we were also matching interest expenses that were allowable deductions with the earning of assessable income." Cottam also testified as to the complexity of the debt and equity lines within the Group. He also attributed this to the difficulties over the years of finding the most appropriate corporate entities within which to place new acquisitions and the most appropriate way of funding them, as well as to the fact that many of the companies involved were "inherited" as subsidiaries as a result of larger takeover transactions. I accept that the debt and equity lines were complex. 74 IEF was established as the in-house finance company of the Group in the mid 1980s. This development and the introduction of the company tax loss grouping provisions at about the same time made it possible to avoid a number of the problems referred to in pars 42 and 43 of Daniels' affidavit set out in the immediately preceding paragraph. Daniels stated: "… I was aware that tax losses could be transferred to wholly owned group companies that had earned assessable income. I was also aware that it was possible to reduce the number of debt lines and the consequential problems by funding companies by equity."

Introduction of the dividend imputation system 75 Although the franking system was introduced with effect from 1 July 1987, its introduction was the subject of development announcements and its likely effect was being discussed in the business community from approximately late 1985. Daniels recalled that the need for IEL to pay franked dividends in order to satisfy its shareholders was "the subject of regular and detailed discussion at administration team meetings". He stated: "Reviewing the existing structure of the IEL Group and determining the need for any changes to it to facilitate the payment of franked dividends to shareholders was a task for which I assumed primary responsibility." IEL announced to its shareholders (of which Daniels was one) in about early 1987, its intention to pay franked dividends to any shareholder who wanted them. Daniels said he worked with the Administration Team members, including Latham and Cottam, towards ensuring that franked and unfranked dividends could be passed up to IEL so that it could meet its operating expenses and the expectations of its shareholders.

Dividend traps 76 Daniels stated as follows in his affidavit: "... I had been involved in the flow of dividends up through the IEL group for a number of years. I also knew that the structure of the IEL group at that time did not readily support the flow of dividends up to IEL, even though IEL was still able to pay dividends. In any given year for instance, a number of IEL group companies inevitably made accounting losses. Typically, these companies were the intermediate holding companies of other IEL group subsidiaries that were profitable and able to pay dividends. This usually occurred because the holding company had borrowed to acquire equity in [or lend money to] the subsidiary. In turn, the subsidiary would use the [funds] raised to acquire income-producing assets. This left the parent company with a loss represented by interest on the borrowings. In consequence, the holding company's financial statements or accounts, usually showed the holding company as having a net asset deficiency. This meant it had no fund of profits available from which to declare a dividend. This led to a multiplicity of 'dividend traps', as I called them, across the IEL group. This occurred because a dividend paid to a loss making parent company by a profitable subsidiary, could not be passed on to shareholders, until such time as it had a fund of distributable profits available. If dividends received by a loss making holding company were fully or partially franked, any franking credits associated with them would also be trapped within the loss making entity. It was part of … my role to minimise the incidence of such dividend traps, so that dividends, franked and unfranked, could be passed up to IEL to enable it to meet expenses and pay dividends. This was increasingly difficult to achieve with the complexity of the IEL group at the time." Cottam also testified as to the dividend trap problems encountered in the Group prior to the Spassked Restructuring.

Wastageof tax losses 77 Daniels stated: "Another matter that concerned me was the related problem of 'wastage' (as I saw it) of tax losses, which in commercial terms, represent an asset of the company concerned. My understanding of tax law at the time was that for tax purposes, a dividend received by a company had to be used first to offset tax losses incurred or carried forward in a given year. The payment of a dividend in such circumstances would result in the wastage of the tax loss asset. In effect, such wastage would reduce the wealth of shareholders in a company with current tax losses. It was part of my role to work with the IEL group tax manager to reduce the incidence of this occurring." Cottam testified that the benefit of the s 46 rebate was foregone where parent companies in the Group had losses which the Act required to be deducted from any dividend received by them before amounts of their taxable income and of tax payable could be ascertained, against the latter of which alone any rebate could be applied.

The Spassked Proposal 78 By late 1986 or early 1987, because of the concerns mentioned above, Daniels was convinced that an internal rationalisation was a "priority for the IEL Group". To this end he had meetings and discussions with Latham from early 1987, and also, from mid 1987, with Cottam. They examined possible restructurings. As well, Daniels raised his concerns with the then chief executive officer, Rodney Francis Price ("Price"), who asked him to see what he could come up with. 79 Daniels discussed with Latham and Cottam the possibility of allotting to IEL "dividend access shares" in the various intermediate holding companies or trading subsidiaries, or both. The purpose of such an allotment would be to facilitate the payment of franked dividends to IEL, which it could "pass on" to its shareholders. Daniels said, however, that this would have complicated further the already complex shareholdings in the Group. Daniels said he saw it as an advantage to reduce the number of companies in which IEL had direct shareholdings. 80 According to Daniels, he, Latham and Cottam consulted a number of IEL Group company directors, employees and external advisers, including the Group's auditors, and devised the Spassked Structure. In his affidavit he stated as follows: The Spassked Proposal involved the following elements: (a) Spassked (a wholly owned shelf company of IEL of which Mr Price, Dr Weiss [Dr Weiss was corporate counsel for the Group and a member of its Investment Team] and I were directors), would borrow funds from IEF (of which Mr Price, Dr Weiss and I, were also directors), at a commercial rate of interest, which was to be capitalised (by which I mean that the interest expenses that would be incurred by Spassked on its loans from IEF would be added to the principal and from that time also be subject to interest which would occur by crediting the interest income in the books of IEF, and debiting the interest expense in the books of Spassked); (b) Spassked would use the funds borrowed from IEF to subscribe for 'A' class shares that would be issued by GIH (known, until 12 November 1988 as Bikinga Pty Limited, which was a wholly owned shelf subsidiary of Spassked, of which Mr Price, Dr Weiss and I, were directors). The articles of association of GIH would be changed so that it could allot 'A' class shares that would carry the right to both franked and unfranked dividends, and 'B' class shares that carried the right to franked dividends only; (c) IEL would subscribe for 'B' class shares in GIH, entitling IEL to franked dividends only; (d) GIH would use the subscription moneys received from Spassked and IEL to acquire shares in either: (i) shelf companies or entities already held by the IEL group, or newly incorporated shelf companies; or (ii) IEL group companies with existing assets, by subscription or purchase, that were expected to produce a franked dividend stream; (e) Those companies referred to in subparagraph (d)(i) above would deposit their funds with IEF at interest, until such time as the funds were required for a specific offer, acquisition or investment. For those companies referred to in sub-paragraph (d)(ii), the funds would be applied to existing inter-company debt, and to the extent that there was a surplus of funds, this would be deposited with IEF at interest." 81 In cross-examination, Daniels agreed that an additional element of the Spassked Structure was that Spassked would incur losses which it would transfer to other members of the Group.

Expectations inrespect of the Spassked Restructuring 82 Daniels testified in his main affidavit about his expectations as to the outworking of the Spassked Restructuring. 83 It was proposed that most future acquisitions and investments by the Group would be made by the Subcos (which, with Spassked and GIH themselves, are referred to below as "the Spassked/GIH sub-group"). Daniels said he expected that the Spassked/GIH sub-group would invest in some pre-existing companies in the Group which were expected to pay franked dividends. He said he believed there was an "administrative advantage" in locating wholly owned subsidiaries of the Group within the Spassked/GIH sub-group so that the IEL Group could take advantage of the tax loss grouping provisions. 84 A matter which was the subject of cross-examination referred to below was the following assertion of Daniels: "It was my intention in formulating the Spassked Proposal, that both Spassked and GIH would have their own requirements for income, and that both would ultimately receive dividends from their respective investments. As a director of Spassked and GIH, I was aware that relative to the size of the IEL Group, the Spassked Proposal would involve substantial sums of money being borrowed by Spassked from IEF at commercial rates of interest. I was also aware that Spassked, as a result of incurring these liabilities, would be likely to have losses in its early years." (my emphasis) 85 Daniels knew that in the early years Spassked was likely to be a dividend trap, but saw it as an advantage of the Spassked Structure that one dividend trap would replace many. He said he believed that this would result in the Group being easier to manage. He continued in a passage which is at the heart of the factual issue I will have to address in due course: "I also recognised that, as a consequence, there would be little benefit to Spassked, or IEL, if dividends were passed up to Spassked in a piecemeal manner. Accordingly, I expected that, over time, dividends would be passed up to GIH, and that at an appropriate point in time, the Board of GIH would declare one large dividend to Spassked." I expected that after a few years, Spassked's debt to IEF would be repaid so that Spassked would cease to be a dividend trap. I cannot recall considering at the time of developing the Spassked Proposal precisely how this would be done. To the extent that I considered it, I recall thinking the most likely way Spassked would do this would be through the profits of GIH and its subsidiaries being used to fund a dividend, or that they would make some other distribution or payment to Spassked to enable it to retire the debt to IEF. The profits of GIH and its subsidiaries would be made from the businesses of those companies or from the sale of investments. I expected that the aggregate economic gains generated from the investments would be more than sufficient to extinguish the debts of Spassked to IEF at some point in the medium term." (my emphasis) Daniels discussed the proposal with Latham and Cottam. They were not directors of Spassked (Cottam was later appointed as a director of Spassked in 1998), but were Group Tax Managers. Cottam recalls that the Administration Team was told that Price had given his approval in December 1987. Daniels said that when he, Latham and Cottam formulated the proposal, and when he secured Price's agreement to it and took steps to implement it, he expected: · that GIH would use the funds obtained from Spassked to invest in Subcos; · that the Subcos would own, or acquire, income producing assets or trading companies; · that the Subcos would, in turn, pay dividends up to GIH as each of their investments matured; · that the Subcos would, upon maturity of their investments, pay dividends up to GIH, to enable GIH to deliver a return to its shareholders, Spassked, and IEL; · that Spassked would receive dividends from GIH once GIH's investments in underlying Subcos began to mature and to produce a fund of profits from which dividends could be paid; · that GIH would be in a position to pay dividends to Spassked; · that once Spassked ceased to be a dividend trap, it would ultimately pass dividends up to IEL; · that any proposed investment by Spassked in GIH would be assessed by Spassked's directors' taking "a portfolio approach", that is, a decision based on a consideration of the Spassked/GIH sub-group as a whole; · that, overall, profits within the Spassked/GIH sub-group would significantly exceed losses within that sub-group; · that IEL would have a continuing obligation to pay dividends to its shareholders and to meet its operating expenses; · that IEL would pay its shareholders franked dividends and would pay them unfranked dividends only in the event that it had insufficient franking credits to "fully frank" the dividends; · that upon implementation of the Spassked proposal, GIH would become IEL's principal source of franked dividends to meet the expectations of IEL's shareholders, and that Spassked would eventually become IEL's principal source of unfranked dividends, and further franked dividends, with which to meet the operating and other expenses of IEL, and to provide a fund of profits to pay dividends to IEL's shareholders; · that IEL would invest $150,000,000 in "B" shares of GIH, which would entitle IEL to franked dividends only, and a return of capital only, with no entitlement to participate in surplus profits on liquidation (Daniels said he understood that the $150,000,000 was based on the approximate present value of the stream of franked dividends expected to emanate from the portfolios of companies that would form part of the Spassked/GIH sub-group, and that this figure approximated the amount of franked dividends expected to be required by IEL's shareholders); · that Spassked, having received franked and unfranked dividends from GIH, would pay to IEL both franked and unfranked dividends; · that Spassked would receive "the major proportion of the initial dividends from GIH" because the profits of the Subcos "would be grouped against the losses of IEL subsidiaries, of which Spassked would form the dominant part", so that "the profits would be unfranked, at least to the extent of these losses". 86 Daniels stated that: "To the extent that the profits of the subsidiaries exceeded available losses, such profits would be subject to tax and would therefore carry imputation credits. Although IEL might be theoretically entitled to these profits under the Spassked Proposal, my intention in implementing the Proposal was that the majority of these dividends would flow to Spassked as dividends from GIH. It was my expectation that there would be an equitable distribution of these dividends, based upon the quantum of capital subscribed for. (my emphasis) Over the three years 1988 to 1990 Spassked subscribed for $3,457,142,866 worth of "A" shares in GIH and IEL subscribed for $150,000,000 worth of "B" shares in GIH, and over the seven years 1988 to 1994, Spassked received unfranked dividends totalling $43,962,139 and IEL received franked dividends of $33,378,828. Clearly, if Daniels' expectation was indeed "that there would be an equitable distribution of ... dividends", that expectation was not fulfilled as events transpired. 87 Daniels said he further expected: · that the future investment activities of the Spassked/GIH sub-group would yield a commercial return greater than the borrowing costs incurred by Spassked, this expectation being based on the quality of investments which Daniels expected the Subcos to make and the "investment track record" of the IEL Group over the many years of his employment; · that reasonable returns on the Spassked/GIH sub-group's investments, significantly in excess of its costs and expenses, would materialise; · that the interest expense incurred by Spassked would "essentially match the interest income derived by those GIH subsidiary shelf companies, which placed their funds on deposit with IEF at interest, while awaiting suitable investment opportunities to present themselves"; · that once the Subcos recalled their deposits with IEF to fund investments by the Subcos, the interest income previously earned by them would be replaced by the income they would earn on the assets they acquired; · that "the interest deductions of Spassked would then be grouped against the income derived by the IEL group companies, including [the Subcos], in accordance with the grouping provisions in [the Act]"; · that IEF would return the income derived on its interest bearing loans to Spassked as assessable income and that the Spassked Structure would not "give rise to any material tax advantages". 88 Daniels stated: "I recall that I was aware that interest incurred by Spassked would not be set off in the early years against a receipt of what otherwise would have been rebateable dividends. I believed, however, that the Proposal in this regard merely involved a consolidation of what had been occurring in the IEL group for some years. Immediately prior to the implementation of the Proposal, for instance, other subsidiaries of IEL were incurring similar amounts of interest expense and had been deferring the receipt of dividend income from their share investments." 89 Cottam said that the Spassked Structure was at a "relatively advanced stage" when he joined IEL in June 1987. He said he recalled being at meetings at which it was discussed and that he "agreed in principle" to its introduction. He said one of the principal advantages he envisaged would flow from the Spassked Structure was that it would "make it much simpler to decide where to place new acquisitions within the IEL group and to a lesser extent avoid the dividend traps and the diverse debt and equity lines [referred to in his affidavit - see [73] above]", and that it would be possible to have suitably capitalised subsidiaries readily available through which to make investments. He said that this aspect was important because the choice of vehicle to be used for an investment often had to be made suddenly and sometimes without knowledge of a proposed acquiring company's previous activities. 90 Cottam also referred to the reduction in the number of debt and equity lines as reducing the problems of dividend traps and loss of tax rebates in respect of dividends passing through the Group.

Implementation of the Spassked Structure 91 The Spassked Structure was implemented in a series of transactions. The loans by IEF to Spassked, Spassked's investments in GIH, and GIH's investments of the money invested in it by Spassked, were not done according to a timetable, but: "… [t]he quantum and timing of capitalisations and investments was largely determined by what [Daniels] and [his] fellow directors perceived to be the priorities of individual companies over time as well [as] the issues affecting the management of the IEL group as a whole, at any given point in time." 92 A reason why the amount of equity invested by GIH in the shelf companies differed as between them was, according to Daniels, "to allow for a wide spectrum of investment opportunities". Daniels testified that as companies were already capitalised with funds on deposit at IEF ready to make investments, "it was simply a matter of selecting a shelf company with the appropriate level of capitalisation". 93 Daniels said that in the period 30 December 1987 to 29 June 1990 he had a series of meetings with other directors of IEF, Spassked, GIH and the Subcos. The meetings were informal and no records were kept of them. They concerned the amounts which Spassked was to borrow from IEF and to invest in GIH, and the amounts which GIH would use to capitalise various Subcos in return for shares in those Subcos. 94 There were ten transactions, which Daniels described and were illustrated by a series of diagrams tendered by Spassked. I think it adequate for me to summarise in the immediately following paragraphs Daniels' account of the first transaction and to annex all ten diagrams to these reasons (in addition, there is an eleventh diagram, the third in the series, which illustrates IEL's subscription for "B" shares in GIH - see [105] below). 95 On or about 30 December 1987 Daniels and Dr Gary Hilton Weiss ("Weiss"), who was corporate counsel for the Group, a member of the Investment Team, and, like Daniels, a director of IEF, Spassked and GIH, agreed that:

• IEF would lend $25,000,000 to Spassked at the commercial rate of interest then being used within the Group for loans by IEF;
• Spassked would deposit a cheque for that amount into GIH's bank account later the same day;
• in return, GIH would issue "A" shares to Spassked to the same value;
• GIH would invest the funds received from Spassked in certain identified Subcos. 96 On 18 January 1988 Daniels attended a meeting of the members of GIH in his capacity as a director of GIH. Weiss was also present as chairman of the meeting and as the duly appointed representative of Spassked. It was resolved that GIH's articles of association be amended, and that $100,000,000 ordinary shares in the capital of GIH be converted to 50,000,000 "A" shares and 50,000,000 "B" shares. The amendments to the articles defined the rights of the two classes of shares as described at [40] earlier. A sum of $25,000,000 had been transferred from IEF to Spassked and from Spassked to GIH on 30 December 1987. On 30 December 1987 GIH issued "A" shares to that value to Spassked (this issue was initially recorded in the accounts of GIH as having taken place on 28 January 1988, however, subsequent records of both GIH and Spassked indicate it took place on 30 December 1987). On 30 December 1987 GIH used the $25,000,000 to subscribe for shares in Harbour Securities Pty Ltd, which, in turn, used $7,322,671.77 of that amount to repay a debt it owed to IEF and placed the balance of $17,677,328.23 on deposit with IEF at interest. 97 Also on 18 January 1988 IEF lent Spassked $950,000,000 with which it subscribed for "A" shares in GIH. GIH used that amount to capitalise twelve Subcos on that date.

98 The two amounts ($25,000,000 and $950,000,000) deployed in the capitalisations on 30 December 1987 and 18 January 1988 represented just over 27 per cent of the total sum of $3,531,392,233 which Cottam said in his affidavit was similarly invested by GIH in Subcos during the period 30 December 1987 to 30 June 1992 (see [111] below).

99 On 2 February 1988 IEL subscribed $150,000,000 for "B" shares in GIH. On that day, that amount was debited to IEL's bank account and credited to GIH's. In cross-examination, Daniels said that the amount of $150,000,000 was arrived at as the amount of share capital thought necessary to support that stream of franked dividends which it was estimated IEL would need to meet its shareholders' expectations. This transaction of 2 February 1988 differs from the other ten referred to earlier, all of which commence with IEF lending to Spassked, because IEL did not borrow the sum of $150,000,000 from IEF, and, of course, payment of that sum to GIH resulted in the issue of "B" shares to IEL rather than "A" shares to Spassked. GIH placed the sum of $150,000,000 paid to it by IEL for the "B" shares on deposit with IEF.

100 In order to effect the Spassked Restructuring, amounts were lent by IEF to Spassked as follows:

Tranche No. Date Amount Manner of tranche 1 30 December 1987 $25M Cheque/bank transfer 2 18 January 1988 $950m Cheque/bank transfer 3 31 March 1988 $675m Cheque/bank transfer 4 1 April 1988 $280m Journal entries only 5 15 March 1989 $400m Promissory note 6 30 March 1989 $7,351,681 Promissory note 7 31 May 1989 $999,791,187 Journal entries only ($55m) Promissory note ($944,791,187) 8 15 March 1990 $99,999,998 Promissory note 9 19 March 1990 $145m Promissory note 10 28 June 1990 $155m Promissory note Total $3,737,142,866

101 In addition, on or about 31 July 1989 IEF lent Spassked $25,613,377 at interest to be applied by Spassked in eliminating a foreign exchange loss it had sustained. 102 Spassked used the above total of $3,737,142,866, as to $3,457,142,866 in subscribing for "A" shares in GIH, and as to the balance of $280,000,000 as an interest free loan to GIH. 103 By 30 June 1990 as a result of the ten transactions and the additional borrowing of $25,613,377 referred to in [101] above, Spassked had borrowed from IEF a total of $3,762,756,243. On 13 March 1989 Spassked paid $280,000,000 to IEF, reducing its indebtedness to IEF as at that time to $1,650,000,000 (excluding capitalised interest). 104 With the following exceptions, all of the funds lent by IEF to Spassked were invested in "A" shares in GIH and were, for the most part, invested by GIH in Subcos: first, the $280,000,000 constituting tranche 4 was lent by Spassked interest free to GIH and invested by it in two Subcos; and, secondly, of the funds in tranche 7, $55,000,000 was used by Spassked to pay a debt it owed to GIH. (Again, there was also the special purpose loan of $25,613,377 referred to in [101] above.) 105 Annexure "B" to these reasons comprises eleven diagrams, including, for convenience, as the third, a diagram representing the subscription by IEL for $150,000,000 of "B" shares in GIH as well as the ten transactions commenced by the loans from IEF to Spassked listed at [100] above. 106 On a cumulative basis, the following were the annual amounts of capitalised interest incurred by Spassked to IEF and the respective amounts distributable and distributed by GIH to Spassked by way of dividends.

Year Interest Distributable Distributed 1988 $113,184,429 $98,625,459 Nil 1989 406,405,066 304,868,025 Nil 1990 1,064,892,295 901,363,305 29,308,093 1991 1,839,638,821 1,338,749,042 29,308,093 1992 2,727,804,345 1,729,279,541 43,962,139 1993 3,193,431,043 2,108,727,039 43,962,139 1994 3,272,715,111 3,045,199,551 43,962,139

The applicants rely on these figures as showing that there were large amounts of profits in GIH distributable to Spassked by way of dividend. Their submission is, as noted elsewhere, that significant dividends were not paid by GIH to Spassked because of the supervening takeover by the Adsteam Group and its financial difficulties and the (disputed) claim of the Australian Taxation Office ("ATO") that the interest expenses of Spassked had not been deductible and the losses had not been available to be transferred, with the result that there were sizeable tax liabilities in the Group.

Interest 107 In the period 1 July 1987 to 30 June 1994, Spassked incurred interest expenses on the sums borrowed from IEF, which were capitalised as follows: Financial year ended 30 June Date Amount Yearly total 1988 30 June 1988 $113,184,429 $113,184,429 1989 30 June 1989 $293,220,637 $293,220,637 1990 31 July 1989 $6,185,855 31 December 1989 $222,706,284 29 June 1990 $279,901,666 30 June 1990 $149,693,424 $658,487,229 1991 31 December 1990 $355,339,552 30 June 1991 $419,406,974 $774,746,526 1992 1 January 1992 $429,291,262 30 June 1992 $458,874,264 $888,165,526 1993 31 December 1992 $248,000,952 30 June 1993 $217,625,789 $465,626,741 1994 31 December 1993 $64,714,794 30 June 1994 $14,569,229 $79,284,023 TOTAL $3,272,715,111

(With only minor differences, the evidence supported these figures. The amount of $658,487,229 for 1990 incorporates an interest adjustment of $149,693,424 made on 1 July 1990. After 1992 the amounts of annual interest were lower because GIH began lending to Spassked interest free, and Spassked applied the funds borrowed from GIH in reducing its interest bearing debt to IEF.) The above amounts were claimed by Spassked as deductible losses or outgoings and returned by IEF as assessable income, in their respective income tax returns for the years ended 30 June 1988 to 30 June 1994. 108 The rates of interest charged by IEF to Spassked were set by the Treasury group within IEL, and were, to the best of Daniels' recollection, "akin to the prevailing market rates, such as the three year swap rate". From about 1991 IEF added a component to reflect "line fees and other borrowing costs, plus a small margin to ensure that IEF would make a small profit on the loans". 109 As noted earlier, Spassked repaid its indebtedness to IEF, including capitalised interest, in 1994. It used for the purpose money it borrowed interest free from GIH and, as to a small amount, from IEL. 110 The interest expenses Spassked incurred to IEF, the dividends Spassked received from GIH, and Spassked's claimed losses for the 1988 to 1994 years are as follows: Year Interest expenses Unfranked dividends received Spassked's to IEF from GIH losses (per income tax returns) 1988 $113,184,429 $113,185,387 1989 293,220,637 293,220,691 1990 658,487,229 $29,308,093 654,610,528 1991 774,746,526 774,746,571 1992 888,165,526 14,654,046 873,693,604 1993 465,626,741 465,626,785 1994 79,284,023 79,284,032 Total $3,272,715,111 $43,962,139 $3,254,367,598

The above table shows that the amounts of Spassked's claimed losses were generally in line with the amounts of the interest expenses it incurred to IEF.

Investment by Subcos 111 During the period 30 December 1987 to 28 June 1990, GIH used funds received from Spassked to invest in Subcos, as appears in the table which is Annexure "C" to these reasons. According to Cottam's affidavit, the total consideration paid by GIH for shares in the Subcos was $3,531,392,233. But an addition of the amounts of "total consideration" shown in the annexure to these reasons gives a total of $3,531,314,466 - a difference of $77,767. The difference is immaterial. In the interests of consistency I will use Cottam's figure of $3,531,392,233. In that period GIH also lent to companies in the Group. 112 The Subcos used the funds invested in them by GIH to invest in a wide range of well known public companies, including, for example, Woolworths Ltd ("Woolworths"), Southern Farmers Group Ltd, Pioneer International Ltd, Kern Corporation, Queensland Trading and Holding Company, Bell Resources Ltd, St George Building Society, Minoil Securities Ltd, Bundaberg Sugar Company, Carringbush Corporation, Rothmans Holdings Ltd and Rothmans of Pall Mall, Caltex Ltd and Sagasco Ltd. The shares were acquired as a result of subscription or transfer upon purchase.

Franked and unfranked dividends 113 Daniels testified that his original intention when the Spassked Structure was put in place was that the only pre-existing companies in the Group in which GIH would invest would be those having a stream of franked dividends (such as Harbour Securities Pty Ltd, which was the principal share trading company within the Group at the time). All the investments which GIH made on 18 January 1988 were of that kind. 114 Daniels stated that at some time in 1988 or 1989 he decided that the Spassked Structure should also be invoked in respect of existing companies in the Group, regardless of whether they were expected to pay franked or unfranked dividends. His reason was that he had come to appreciate that many of the Group's existing investments would also generate significant future earnings and that the Spassked Structure offered administrative, financial and planning benefits. Daniels said he recognised that if he brought these additional companies within the Spassked/GIH sub-group, they would deliver a financial return and increase the possibility of franked dividends being paid (no doubt he had in mind the possibility of the relevant tax being paid by the company receiving an unfranked dividend - see [199] subpar 23 below). As a consequence, from about 1988 or 1989, most of the Group's operating companies and companies with other income producing assets, became part of the Spassked/GIH sub-group.

Takeover of IEL by the Adsteam Group in November 1989 115 Daniels was working in Switzerland between May 1990 and March 1991 as a branch manager of an IEL Group company. It was in November 1989 that the Adsteam Group, through Dextran, acquired IEL. On the basis of his discussions with Mr Eggert, an IEL Treasury officer, and his reading of the financial press, Daniels learned that the three members of the Adsteam Group had begun to experience financial difficulties in or about November 1990. I have referred earlier to the subsequent events. Daniels said he had no doubt from November 1990 that the IEL Group, being the principal asset of the Adsteam Group, would have serious restrictions placed on its operations by its lenders, and, indirectly, by the lenders to the Adsteam Group. He thought at the time (November 1990) that the Group was in de facto administration, with no future, and no raison d'ętre other than to realise its assets. Daniels said it was at this point (November 1990) that he "first had some doubts about whether Spassked would ever receive dividends exceeding its aggregate cost of borrowings". Daniels said he expected that the Group would probably be put into voluntary administration or liquidation, and that the proceeds of its assets would be used to repay the external debts of IEL, Dextran, and Dextran's shareholders (the three members of the Adsteam Group). 116 David John Ryan ("Ryan"), who was at the time an executive of Bankers' Trust ("BT"), testified as to events in and from May 1991. In that month BT was appointed with the approval of a small working party representing the interests of bankers to the Adsteam Group, as financial advisers to the Adsteam Group. According to Ryan, BT's task was "to develop a financial plan to enable the core businesses of the Adsteam Group to continue trading, meeting liabilities, and delivering a return to shareholders, while the Group's assets were progressively being realised, so as to avoid a fire sale". The Adsteam Group's banks were involved through a committee formed on 8 April 1991 chaired by a partner of KPMG ("the Adsteam Committee"). The banks agreed to an informal moratorium on debt and interest payments by the Adsteam Group while the Adsteam Committee was considering the financial position of the Adsteam Group. 117 In September 1991 the Adsteam Committee adopted BT's plan which Ryan was instrumental in formulating. Ryan said that when he became involved in the IEL Group in 1991, it had external gross assets of approximately $3.8 billion and an overall net asset value of approximately $1.2 billion, was one of the largest and most diverse corporate groups in Australia, and employed well over 50,000 staff. But by the time of his oral testimony on 17 April 2002, the Group had no employees and functioned only through non-executive directors, and virtually all its operating assets had been sold. A major part of Ryan's role was to direct and manage the sale of assets and the restructuring or retirement of internal and external debt. 118 On 20 December 1991 Spassked and IEF entered into a deed by which Spassked acknowledged that it owed IEF $5,322,395,000 and undertook to pay interest on its indebtedness to IEF from time to time at "the Bank Bill Rate" (as defined) plus 9 per cent per annum, or such lesser rate as the parties might agree. 119 Ryan was appointed an executive director of IEL on 10 February 1993. 120 In his affidavit, Ryan identified the progressive selling off of the Group's assets between 1994 and 2001, commencing with the sale of Woolworths in 1994 for $2,450,000,000. The proceeds of asset sales were used to repay the external debt of the Group, or passed up to IEL by way of loans. The external debt was repaid in full on 13 July 1993, and therefore by the end of the financial year ended 30 June 1994. As part of the same process, Spassked's debt to IEF was repaid by 1 July 1994. Of course, from that time, Spassked ceased to incur interest to IEF. 121 From 1991, surpluses from the asset sales were paid by IEL up to Dextran and by Dextran up to the members of the Adsteam Group, then used by them to pay, in part, their debts. 122 As at 30 June 2000, the Group had been assessed for income tax in amounts totalling of the order of $2.176 billion, comprising primary tax of the order of $1.148 billion and additional tax, penalties and interest of the order of $1.028 billion. 123 Daniels stated that in order to avoid a "fire sale" the Group was not placed into liquidation. However, he was convinced by the restrictions placed on IEL by its lenders in November 1990, and a Multi-Option Facility Deed dated 31 December 1991 entered into by IEL, IEF and the other members of the IEL Group, and the Group's lenders, that the chances of the Group's continuing as a going concern were low. Daniels said that as a director of most of the head office companies of IEL, he knew from that time that the companies within the Group were no longer pursuing further investments or avenues for growth. He stated: "Until the collapse of the Adsteam group in late 1990, I had no doubt, given the quality of the investments ..., and the IEL group's management skills and track record, that the Spassked group would yield returns in excess of the funding costs incurred by Spassked." As a director of the companies which were the members of the Spassked/GIH sub-group, and which were, at that time, contemplating realising assets, Daniels formed the view that because of the financial problems of the Adsteam Group, those companies would lose much of their bargaining power with prospective purchasers. He stated: "… I believe this lack of negotiating leverage and the fact that some assets had to be realised prior to maturity under the financing arrangements agreed to with the banks in late 1990 (later formalised in the Multi Option Facility Agreement) contributed to profits being lower than originally anticipated." 124 The interest rates charged by IEF on its loans increased because they were floating rates tied to the market. They peaked at 17.25 per cent in 1991. Daniels said that as a director of Spassked back in 1987, he had not expected them to reach that level.

Payment of dividends by GIH to Spassked 125 Daniels said that it was contrary to his earlier expectations that Spassked had only ever received the two unfranked dividends totalling $43,962,139 from GIH.

Negotiations with Australian Taxation Office 126 Shortly after Daniels returned from overseas to IEL's head office in March 1991, he began working with Cottam on tying up loose ends in relation to a settlement which he understood had been reached with the ATO in March 1991. Heads of agreement were prepared in March 1991 between IEL, the three members of the Adsteam Group, National Consolidated Ltd and Petersville Sleigh Ltd and subsidiaries and associates, and the ATO, in relation to all outstanding taxation claims in respect of the year ended 30 June 1987 to the year ended 30 June 1990. The Heads of Agreement document dated 21 March 1991, as amended on 15 May 1991, provided for $300,000,000 of revenue losses to be carried forward, on condition that the ATO was satisfied as to the validity of the losses. As events transpired, it was not so satisfied. Daniels stated that Deloitte Ross Tohmatsu ("Deloittes"), a firm of chartered accountants retained by IEL at the time, indicated to the Commissioner that Spassked was the appropriate entity in the Group to carry forward the greater part of the $300,000,000 of losses. Daniels stated: "… The decision to nominate Spassked was made, based on a recommendation by Mr Cottam and I. This seemed to us the most equitable approach to take having regard to the fact that Spassked, with approximately $600 million of carry forward revenue losses, had the greatest quantum of tax losses across the Adsteam group, as well as [the] greatest number of operating businesses." 127 Daniels said that at the time when Spassked was nominated, he expected that the process would be dealt with quickly and that the parties would then execute a final deed of settlement. He said his "expectations abruptly changed when the ATO began asking, in about April 1991, for substantial amounts of information in relation to the losses in relation to Spassked, and also the IEL group". 128 At that time (about April 1991) Daniels and Cottam attended a meeting with representatives of the ATO in which some of the ATO officers explained that the Commissioner was not satisfied that the losses in Spassked were available, and was considering the application of subs 51(1) to the question of the deductibility of Spassked's interest expenses and of Part IVA to the Spassked Structure as a whole. 129 Following the meeting, months passed during which discussions and exchanges of correspondence continued. On 16 December 1991, Peter Walmsley ("Walmsley"), an officer of the ATO, wrote a letter to Deloittes ("the Walmsley letter"), indicating that the Commissioner was not satisfied that there were any tax losses available to be carried forward by Spassked or by any other company in the Group. Daniels stated: "The Walmsley letter left me in no doubt, from this time on, that there was a real possibility that no tax losses would be available to Spassked or other IEL group companies. I considered that this would have a highly adverse impact on companies within the IEL group, particularly those wholly owned IEL group companies that had received, and would be likely to receive, Spassked or other revenue losses pursuant to the loss transfer provisions of the [Act]." Daniels's affidavit continued as follows: "My meeting with the ATO in 1991, and the Walmsley letter, put me on notice, as a director of several hundred IEL group companies of a risk that amended assessments would be issued sometime in the future, negating the tax effect of losses previously transferred from Spassked and other IEL group companies, and creating a contingent liability to tax. Any future loss transfers out of Spassked would also be uncertain, although there was no question in my mind, that it was my duty as a director and as a member of the administration team, to ensure that Spassked's losses were transferred to wholly owned group companies in accordance with the loss grouping provisions. As a director of several hundred companies in late 1991, I was most concerned at the IEL subsidiary company level. I could not assess the impact of the ATO's position on a company by company basis. There were a number of variables or unknowns that I considered, as a director on notice that the interest expenses of IEL group companies, including Spassked, may not be allowable deductions for tax purposes including: (a) As a result of the financial problems of Dextran's shareholders, the IEL group may be put into administration or voluntary liquidation at any time. (b) The receipt of an amended assessment by a company gives rise to a tax debt, regardless of whether the tax debt is affirmed or ultimately upheld on objection or appeal. (c) Notices of amended assessments could be issued at any time. Interest would run on all tax debts from the point at which the tax claimed by the ATO was originally due, even though a Notice of amended assessment could be issued several years later. Future interest rates could not be ascertained. (d) A number of amended assessments could be raised in respect of different taxpayers but in relation to the same underlying tax debt, irrespective of the fact that, at worst, the Commissioner could recover the debt only once. (e) Where an amended assessment is raised there is a risk of penalties, and where Part IVA is applied, a penalty of up to 200% of the primary tax due under the assessment could be payable. This was capable of being remitted only at the Commissioner's discretion. I continued to have these concerns until my departure from IEL on 30 June 1994." 130 Daniels said he shared his concerns with other directors of the companies in the Group, including Mr Eggert and the company secretary, Mr Hartigan. According to Daniels, a consensus was reached that great care had to be taken in relation to all decisions made by directors of companies in the Group, "particularly given the personal risks that might arise for breaches of directors' duties under the Corporations Law and what [Daniels] considered to be the real possibility of IEL group companies or the entire IEL group being placed into administration or voluntary liquidation in the near future". 131 Daniels stated as follows in his affidavit: "The clearest manifestation of the decision of myself and of my fellow directors of IEL group companies to be prudent was that, after late 1991, relatively few dividends were declared or paid by IEL group companies. I took the view that the payment of a dividend by a wholly owned IEL group company that had received or would be likely to receive losses from IEL group companies, including Spassked, or which had other potentially contentious taxation issues was almost out of the question. For the reasons discussed [above], I could not be satisfied as a director that there was a valid fund of profits from which to pay a dividend, as a tax debt, the amount of which could not be determined, could arise some time in the future on the issue of an amended assessment. I was aware that payment of a dividend in such circumstances could, on a worst case, amount to an illegal reduction of capital or expose me as a director to personal liability for insolvent trading. From late 1991 to 30 June 1994, I held the view that the above issues had to be resolved before I as a director, was prepared to agree to a declaration of a dividend to the extent that the fund of profits of the relevant company was uncertain. During this period, there were other factors influencing my view. From late 1990, I held the view that there was a real prospect of the IEL group being liquidated, so there would be no need to pay actual dividends. In this period, most of my time, and that of my fellow directors, was dedicated to projects that were designed to maximise the value of the IEL group. Given the financial problems of the IEL group my management time had to be spent on these projects. This meant that dividends could not be 'tracked' up to GIH as I had expected in implementing the Spassked Proposal." 132 Ryan said he saw the uncertainty of the tax position of the IEL Group as "a major impediment to the ultimate winding-up of the IEL Group, which as chief operating officer of the holding company, IEL, [he] was very keen to achieve". Ryan said that from 1993 he had a number of discussions with directors of IEL, both individually and at board level, and with Cottam, about IEL's tax affairs. As well, he said he attended several meetings with officers of the ATO. Ryan said that since he was appointed as a director of IEL, Spassked, GIH, and a number of the Subcos on 10 February 1993, there have been more than forty meetings between IEL Group officers or employees and the ATO in an attempt to settle outstanding tax issues affecting the Group, and that he, Ryan, attended most of those meetings. As well, the Group and the ATO engaged in a considerable amount of correspondence, the Group provided voluminous documents to the ATO, and the ATO conducted examinations under s 264 of the Act of Daniels, Cottam and Mr Eggert, as well as of Graham Libbesson, a tax accountant and former adviser to IEL.

Liquidation project 133 In his final years as an employee of IEL, Daniels worked with members of the Administration Team, including Cottam, on projects designed to bring about cost savings in corporate, tax and accounting compliance expenses. In February 1992 he briefed the IEL board as to alternative methods of disposing of defunct or dormant companies in the Group. By 25 March 1992 a preliminary list had been compiled of companies with few assets which seemed to be easily eliminated through deregistration. However, by September 1992 Daniels had come to the view that the Commissioner would not produce certificates under s 215 of the Act in relation to most of the companies affected, or potentially affected, by outstanding taxation issues. He considered that this meant that the directors of Group companies would be left with a structure, comprising several hundred companies, even after the asset divestment program had been completed. As at 30 June 1994, there were still more than 500 companies in the Group (reduced from 653 in 1991), only 76 of which were in voluntary liquidation. 134 According to Daniels' affidavit, on 29 June 1992 the directors of the companies in the Group resolved upon a program of causing amounts advanced to IEF or to any other company in the Group (other than shareholders) to be repaid, as considered appropriate; of repaying any third party liabilities; and of advancing the net amounts (if any) received, together with any other amounts received, from subsidiaries to shareholders by way of interest free loans. Loans were made in accordance with that program. Daniels said that, until the float of Woolworths on 13 July 1993, he had no concerns about making such loans because the Group had substantial net assets, sufficient to meet any liabilities, including repayment of the loans, and there was no question of insolvency. Following the float of Woolworths there were surplus funds available for distribution from the Group. Daniels knew, from discussions with the directors of IEL, that there was a need to provide funds to IEL, and, in turn, from IEL to Dextran, and ultimately to the Adsteam Group. Otherwise, there was a risk that steps might be taken by external creditors to the Adsteam Group to wind up the IEL Group. But Daniels and Ryan were not prepared to agree to pay funds by way of dividends. Consequently, any funds paid up to IEL were paid by way of loan rather than as dividends. In cross-examination, Daniels said he knew IEL would use any money so lent to it to pay its external debts and to pay any surplus to Dextran. 135 Funds were subsequently lent up to IEL. On 19 July 1993 IEL's debts to its external lenders were paid. In consequence, IEL's and its subsidiaries' obligations to external lenders under the Multi-Option Facility Agreement of 31 December 1991 were discharged. 136 Ryan also deposed to concern over payment of dividends. He said that because of the unresolved claims of the Commissioner, he feared that payment of dividends might involve an illegal reduction of capital, insolvent trading and the commission of an offence under the Crimes (Taxation Offences) Act 1980 (Cth). Ryan said he determined that "on a worst case basis" the IEL Group might end up having to pay $700 million in further tax. Accordingly, after discussion, he and the other directors of IEL Group companies decided that security should be taken over the assets of Adsteam Group subsidiaries, being cash totalling $702 million held in interest bearing accounts. Charges secured $702 million of loans made by IEL to Dextran. Further, IEL had, according to Ryan, net assets of approximately $260 million as at 31 December 2001, of which approximately $259 million comprised cash. In addition, IEL had contingent assets comprising interests in the Woolworths Subvention and Float Trusts totalling $110 million. Finally, as at 31 December 2001 Dextran had cash of approximately $13 million.

Dividends payable 137 In his affidavits Daniels restates certain matters based on statutory accounts and records of the IEL Group companies controlled directly or indirectly by Spassked and he exhibits copies of supporting financial records. In respect of the various years of income, he stated that if he had been able to assume that there was no risk of any company in the IEL Group incurring a tax liability from the denial of Spassked's interest expenses to IEF as allowable deductions, a consolidated fund of profits of a certain amount would have been available to be paid up to Spassked in the particular year and there were net consolidated unrealised gains in specified amounts which would have been available for distribution to Spassked if assets owned by the Subcos were disposed of in the relevant year. The figures were as follows: Consolidated Net Consolidated Fund of Profits Unrealised Gains At 30 June of Year 1988 $98,625,459 $30,919,011 1989 $304,868,025 1990 $901,363,305 1991 $1,338,749,042 1992 $1,729,279,541 $542,983,875 1993 $2,108,727,039 $1,076,174,438 1994 $3,045,199,551 $123,264,041 2000 $3,126,924,146 $205,740,768

Each year down to the year ended 30 June 1997, Spassked transferred losses out to other members of the Group. But not so in the year ended 30 June 1998. In that year Spassked no longer had losses available for transfer.

Agreements for the purposes of s 80G of the Act 138 On 13 March 1993 Spassked, as transferor, entered into agreements for the purposes of s 80G of the Act with IEL and SPL as transferees, transferring to them respectively certain parts of the tax losses which Spassked had incurred in the year ending 30 June 1992 (see [6] earlier). It is uncontroversial that, subject to resolution of the s 51(1) and Part IVA issues in this proceeding, those agreements were effective to transfer the losses according to their terms.

Competency 139 By notice of motion filed on 1 December 2000, the Commissioner seeks an order dismissing Spassked's application as incompetent. The motion turns on the form of the Commissioner's "notice of assessment" to Spassked dated 14 March 1997. 140 The provisions which give rise to the Court's jurisdiction depend on the existence of an "assessment". Those provisions are s 175A of the Act and the following provisions of the Administration Act: ss 14ZL, 14ZQ ("objection decision" and "appealable objection decision"), 14ZY, 14ZZ, 14ZZN and 14ZZO. As well, reference may be made to ss 166, 166A, 169, 170 and 174 of the Act and to Order 52B of the Federal Court Rules. I will refer only to some of these provisions. Section 166 requires the Commissioner to make an assessment of the amount of "taxable income" and of "the tax payable thereon". Consistently with this provision, subs 6(1) of the Act defines "assessment" to mean, relevantly: "(a) The ascertainment of: (i) the amount of taxable income; ... and of the tax payable on that taxable income... ;" 141 Section 175A of the Act provides that a taxpayer who is "dissatisfied" with an "assessment" made in relation to the taxpayer may object against it in the manner set out in Pt IVC of the Administration Act. Part IVC of that Act comprises ss 14ZL-14ZZS. Section 14ZZ provides that if the taxpayer is "dissatisfied" with the Commissioner's decision on the taxpayer's objection, the taxpayer may, if that objection decision is an "appealable objection decision" (as defined in s 14ZQ), appeal to this Court against the decision. (Subject to the Commissioner's contention presently under consideration, the Commissioner's decision on Spassked's objection was an objection decision and an appealable objection decision.) Finally, s 14ZZO provides, inter alia, that in proceedings on such an appeal, the appellant has the burden of proving that the assessment is "excessive" (see s 14ZZO(b)(i)). 142 The Commissioner submits that in the case of Spassked there was no assessment because there was no amount of tax assessed to be payable. 143 Spassked's notice of assessment dated 14 March 1997 for the year ending 30 June 1992 stated, relevantly, as follows: "Taxable Income $14654001 $ c Gross Tax 5715060.39DR Other Credits 5715060.39CR Balance of this Assessment 0.00 Amount payable 0.00 Date Due and Payable 17 APR 97" It will be noted at once that there was an assessment, both of an amount of "Taxable Income" and of "Gross Tax", but that because of a credit, there was a nil "Balance of ... Assessment" and a nil "Amount payable". 144 The Commissioner relied on the following cases: Batagol v Federal Commissioner of Taxation (1963) 109 CLR 243 ("Batagol"); Stuart (No 2) v Federal Commissioner of Taxation (1996) 96 ATC 4942 ("Stuart"); Deputy Federal Commissioner of Taxation v Sheehan (1986) 86 ATC 4718 ("Sheehan"); and Commissioner of Taxation v Ryan (2000) 201 CLR 109 ("Ryan"). 145 In Batagol, due to a misapprehension, officers in the Commissioner's office noted the taxpayer's files in respect of the years of income ended 30 June 1952, 1953 and 1954 to the effect that no tax was payable and that the taxpayer's return had been finally dealt with. The officers overlooked the fact that by a deed of arrangement which the taxpayer had entered into prior to those three years of income, but after he had incurred certain loses which he had claimed to deduct from his assessable income, he had assigned his estate to a trustee for the benefit of his creditors. On the basis that the taxpayer had been released from his debts, there were no longer losses available to be carried forward. Subsequently, notices of assessment were issued to the taxpayer in respect of the three years mentioned. The taxpayer objected. 146 Subsection 170(3) of the Act provided (at the time) that where a taxpayer had made full disclosure, and an assessment was made after that disclosure, no amendment increasing the taxpayer's liability could be made except to correct an error in calculation or a mistake of fact. The taxpayer had made full disclosure and the officers' error was one of law. 147 All three members of the Court (Kitto, Menzies and Owen JJ) were agreed that there had not been, prior to the issue of the notices of assessment, any earlier assessment for the purposes of subs 170(3). The earlier steps taken by the Commissioner's officers did not amount to the making of an assessment: they were merely preliminary steps. 148 Batagol has no relevance to the present case in which: · the Commissioner did issue a purported notice of assessment; and · the question is whether that notice was notice of an "assessment" for the purpose of activating the statutory rights of objection and appeal. 149 In Stuart, a Full Court of this Court dismissed an appeal from a decision of a Judge of the Court who had held that the Commissioner's decision on an "objection" to a nil assessment was not an "objection decision", and therefore not an "appealable objection decision", so that the appeal from that decision was incompetent. Each of six documents headed "nil tax advice" stated that the taxpayer's taxable income was nil and the tax on the taxable income was nil. Each then contained other figures, the effect of which was to claim that the taxpayer owed the Commissioner an amount with respect to liabilities imposed previously. The taxpayer's objection was to "The Other Amounts Payable". The Full Court accepted the Commissioner's submission that his decision that there was no taxable income and no tax payable, was not an "assessment" and that the appellant was not "dissatisfied" with the Commissioner's decision. 150 But in the present case there was an ascertainment of an amount of taxable income and of an amount of tax payable thereon, that is to say, an assessment with which Spassked could be, and was, "dissatisfied" (and which could be "excessive"). 151 In Sheehan, Tadgell J said (at 4724), following Batagol, that "[t]he imposition of a liability is a necessary feature of an assessment under Pt IV of the Act, and a nil assessment is an impossibility". A document headed "Notice of Credit Applied" purported to record that the taxable income for the 1979 year was nil and that no tax was payable for that year. But in the present case, the notice of assessment stipulated an amount of "taxable income" and an amount of "tax payable" on that taxable income. 152 Like Batagol, Ryan was a subs 170(3) case. The taxpayer furnished a return of her income for the year ended 30 June 1987 stating her taxable income as $4,470. The Commissioner issued a document entitled "Refund Notice", stating that the taxpayer's taxable income for the year ended 30 June 1987 was nil; that the tax on the taxable income was "$0.00"; that the taxpayer was entitled to certain credits; and that the "Amount of Refund" to which she was entitled was $3,653.40. More than six years later the Commissioner issued a notice of assessment in respect of the same year of income, stating that the taxpayer's taxable income was assessed to be $14,470. An accompanying adjustment sheet stated that a deduction of $10,000 previously claimed by the taxpayer in her return and allowed, had now been disallowed. It was accepted that the taxpayer had made a full and true disclosure of all the material facts. The issue was whether, in the circumstances, the Commissioner had power to issue the notice of assessment. 153 In their joint judgment, Gleeson CJ, Gummow and Hayne JJ saw the question in the appeal to be whether the time fixed by subs 170(3) had run, that is, whether three years from "the date upon which the tax became due and payable under [the] assessment" had elapsed. Their Honours held that these words were not engaged where there was no tax due and payable. 154 Kirby J dissented. Callinan J agreed with Gleeson CJ, Gummow and Hayne JJ. 155 Again, the present case is distinguishable. This is not a subs 170(3) case: it is an appeal, and the condition of the existence of the Court's jurisdiction is the existence of an "appealable objection decision" with which the taxpayer is "dissatisfied" and which is capable of being shown to be an "excessive" assessment. These conditions are satisfied in the present case. 156 In this case, unlike the four on which Spassked relies, there was, according to the notice of assessment, both an "ascertainment of the amount of taxable income" and an "ascertainment of the tax payable on that taxable income" (cf the definition of "assessment" in subs 6(1) of the Act set out at [140] above). The former amount was $14,654,001. The latter was $5,715,060.39. (There was also a credit of $5,715,060.39.) Spassked was able to be, and was in fact, "dissatisfied" with the assessment of the amount of taxable income and of the amount of tax payable on it, and was therefore able to object to it (see s 175A of the Act). Similarly, Spassked was able to be, and was in fact, "dissatisfied" with the Commissioner's decision on its objection (see s 14ZZ of the Administration Act), and the assessment was capable of being "excessive" (see s 14ZZO(b)(i) of the Administration Act). 157 For the above reasons I would not uphold the objection to competency.

General 158 Subsection 51(1) provided, relevantly, as follows: "All losses and outgoings to the extent to which they are incurred ingaining or producing the assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income, shall be allowable deductions …." (my emphasis) 159 The loss or outgoing in the present case is the interest expense of $888,165,526 incurred by Spassked to IEF in the year of income ended 30 June 1992. Spassked has the burden of proving that this interest was incurred: · (first positive limb) in gaining or producing dividends on Spassked's "A" shares in GIH; or · (second positive limb) in carrying on a business for the purpose of gaining or producing dividends on Spassked's "A" shares in GIH, because those dividends are the only form of assessable income that is relevant, on the facts of the case.

160 Interest is "ordinarily a recurrent or periodic payment which secures, not an enduring advantage, but, rather, the use of borrowed money during the term of the loan" and is "ordinarily a revenue item": Steele v Deputy Commissioner of Taxation (1999) 197 CLR 459 ("Steele") at 470 per Gleeson CJ, Gaudron and Gummow JJ.

161 In Hart v Federal Commission of Taxation (2002) 2002 ATC 4608 ("Hart"), Hill J stated (at 4615-4616, paragraph numbers omitted):

"Two tests have been proposed to determine the deductibility of interest on monies borrowed to acquire income producing assets. The first looks to the purpose of the borrowing; the second, looks to the use to which the borrowed funds are put. Generally, where interest is borrowed to finance the acquisition of an income producing asset it will make no difference which formulation is used. The result will be the same. The interest will be deductible. This is because the purpose of the borrowing will usually be readily seen from examining the use to which the borrowed funds are put. It is unnecessary, therefore, in the normal case to distinguish between the two tests. The question whether a loss or outgoing is deductible under s 51(1) involves a process of characterisation of the loss or outgoing. It will be necessary to determine the essential character of the loss or outgoing, both in examining whether there exists the necessary connection between the incurring of the outgoing and the gaining of assessable income and also in deciding whether the loss or outgoing has, inter alia, the character of private or domestic expenditure: cf Lunney v Federal Commissioner of Taxation (1958) 100 CLR 478 see McTiernan Jat 478 and Williams, Kitto and Taylor JJ at 497; Handley v Federal Commissioner of Taxation (1981) 148 CLR 182 see Stephen J at 187, Mason J at 194, Murphy J at 196, Aickin J at 200 and Wilson J at 202; and Federal Commissioner of Taxation v Cooper (1991) 29 FCR 177 see Lockhart J at 181-182 and Hill J at 201. It has been pointed out in a number of cases, including, for example in Fletcher v Federal Commissioner of Taxation (1991) 173 CLR 1, the relationship between an outgoing and assessable income, that is to say, the question whether the necessary connection exists between them will ordinarily not be affected by the subjective motivation of a taxpayer. At least where a taxpayer derives assessable income from the use of property the connection is apparent on its face. This will be the case, at least, where the loss or outgoing is not grossly excessive and the transaction is one where the parties are dealing with each other at arm's length: cf Ure v Federal Commissioner of Taxation (1981) 34 ALR 237; Federal Commissioner of Taxation v Phillips (1978) 20 ALR 607 and Fletcher v Federal Commissioner of Taxation (1991) 173 CLR 1. Because interest is the cost of borrowing money the connection between the interest and assessable income that is derived or the essential character of the interest outgoing is, as noted above, to be ascertained by looking beyond the loan itself to the use to which the borrowed funds are put: Federal Commissioner of Taxation v Roberts & Smith (1992) 37 FCR 246." Later, his Honour said (at 4616): "the ... interest ... will take its character from the use to which the ... funds borrowed are put" In the same case, Hely J also stated (at 4625): "...interest ... will take its character from the use to which the ... funds borrowed are put." Hely J agreed with Hill J's reasons for deciding that certain compound interest incurred by the taxpayers was deductible, as did the third member of the Court, Conti J. Their Honours may be taken to have agreed with Hill J's statement of the principles set out above, as I do. 162 The "agreement" between Spassked and IEF under which the monies were lent and borrowed and the interest was payable and paid, was made in late December 1987, just before the first loan was made on 30 December 1987, and each time a loan was made down to the tenth and last one on 28 June 1990. The agreement was made between companies having the same directors and its terms were not expressed or recorded in writing. Apparently the amounts borrowed were repayable on demand, whether with or without reasonable notice. The immediate purpose of the loans was to enable Spassked to invest in "A" shares in GIH and that was the use to which the monies borrowed were put. But in substance and reality, that is only the beginning of any adequate account of purpose and use on the facts of this case.

Expectation or purpose 163 Many cases have discussed the significance of the word "in" in the first positive limb of subs 51(1), or its predecessor, s 23(1)(a) of the Income Tax Assessment Act 1922 (Cth). While it is dangerous to substitute other words for those of a statute, it has long been accepted that the word "in" in that context means "in the course of": Amalgamated Zinc (De Bavay's) Ltd v Federal Commissioner of Taxation (1935) 54 CLR 295 at 303 per Latham CJ, 309 per Dixon J; Commissioner of Taxation v Riverside Road Lodge Pty Ltd (in liq) (1990) 23 FCR 305 at 311. This synonymous phrase does little, however, to resolve the issues calling for decision in the present case. 164 In Ronpibon Tin NL & Tongkah Compund NL v Federal Commissioner of Taxation (1949) 78 CLR 47 ("Ronpibon"), all members of the High Court, in a joint judgment, said of the first limb (at 57): "…, to come within the initial part of the sub-section ["losses or outgoings ... incurred in gaining or producing ... assessable income"] it is both sufficient and necessary that the occasion of the loss or outgoing should be found in whatever is productive of the assessable income or, if none be produced, would be expected to produce assessable income." (my emphasis)

Ronpibon was decided by reference to the first limb of subs 51(1). The second limb refers in terms to the purpose of gaining or producing the assessable income of the business to which that limb refers. It is noteworthy that in Ronpibon, their Honours used the words "would be expected" rather than "was expected". This suggests that they had in contemplation an objective test, rather than one turning simply on the subjective expectations of the taxpayer.

165 The word "expect" or any of its derivatives finds no place in the first positive limb of subs 51(1). It will be recalled that Daniels made much use of the word or of derivatives of it in his affidavit. It is important to appreciate that the context in relation to which their Honours used the word in Ronpibon was their reference to "the occasion" of the incurring of a loss or outgoing. They said that expectation of the production of assessable income must provide that occasion. The word "expect" has the primary meaning of "look forward to" (The Oxford English Dictionary; The Macquarie Dictionary). This primary meaning does not carry only a positive connotation, such as, "look forward with pleasure to": one can also "expect" unwelcome things to happen. In this respect, the word is neutral, etymologically speaking. But since expectation is linked in the present context to the occasion of a taxpayer's incurring of a loss or outgoing, their Honours in Ronpibon can have intended only a positive connotation. In the result, references to expectation in the context of subs 51(1), properly signify that the voluntary incurring of a loss or outgoing must be seen to be explicable by the taxpayer's "favourably looking forward to" the gaining or producing of assessable income as a result, or must be seen to be "for", or "for the purpose of", or "directed to" the gaining or producing of such income. It is erroneous to think that expectation in the mere neutral factual sense is sufficient. 166 In AGC (Advances) Ltd v Federal Commissioner of Taxation (1975) 132 CLR 175, both Barwick CJ (at 189) and Mason J (at 195-197) recognised that the words "the assessable income" in subs 51(1) refer to "the assessable income of the taxpayer generally without regard to division into accounting periods". Not only is it unnecessary that the loss or outgoing be referable to assessable income derived in the year of income in which the loss or outgoing was incurred: it is not necessary that there be any assessable income derived at all: Ronpibon; Fletcher v Federal Commissioner of Taxation (1991) 173 CLR 1 ("Fletcher") at 16-17; Steele at 474; Commissioner of Taxation v Consolidated Press Holdings Ltd (2001) 207 CLR 235 at [74], [75]. In the case last cited, the High Court stated in a joint judgment (at [74]): "But it is the relevance of the loss or outgoing to some kind of income, actual or potential, that warrants the conclusion that it is incurred in a manner necessary for the application of s 51(1). It was the purpose of the borrowing, that is to say, the acquisition of shares expected to produce dividends as a result of the BAT takeover, that gave rise to the potential application of s 51(1). On the hypothesis (which is in dispute) that it would be reasonable, in the absence of the tax purpose, to expect that ACP would have subscribed directly for shares in CPIL(UK), and that income in the form of dividends paid by CPIL(UK) as a result of the BAT takeover would have had a foreign source, then it is the fact that the purpose of the borrowing was to obtain such income that made the interest potentially deductible under s 51(1)." (my emphasis) Later (in [75]) their Honours referred to: "the possibility that, in a given year of potential deductibility, the potential or prospective income which makes the loss or outgoing otherwise deductible under s 51(1) has not yet commenced to be derived, or has ceased to be derived" (my emphasis) and continued: "It is not impossible to relate deductions to income which remains merely prospective or potential. Making such a relation may be necessary for s 51 to apply. It was necessary in the present case." In sum, it is not necessary that assessable income be derived: potential or prospective income will suffice, but, again, only if the relationship between it and the borrowing exposes the purpose of the borrowing. The qualification is important in the present case, as will appear later. 167 Both parties treated the present case as a "purpose" case, to use the word of Hill J in Hart and of the second positive limb of subs 51(1), or as an "expectation" (in the sense explained) case, to invoke the terms of Ronpibon. This is understandable. The two unfranked dividends totalling $43,962,139 constituted a miniscule return to Spassked when compared to its borrowings from IEF of $3,737,142,866 over the period 30 December 1987 to 28 June 1990 (see [100] above) or its incurrence of interest to IEF of $3,272,715,111 over the seven years of income 1988 to 1994 (see [107] above). Daniels accepted that the dividends paid to Spassked were "nominal" in the context of "the entirety of the arrangement". Cottam said they were paid "cosmetically", that is to say, for the sake of appearances: he said that since IEL was receiving a dividend, it seemed that Spassked should receive one also, "small as it may be". 168 Where there is an actual derivation of assessable income, the question may be easily seen to be one of the quality and sufficiency of the connection which subs 51(1) requires between the incurrence of the loss or outgoing and that income. An example is provided by the cases concerned with travelling expenses to and from places of employment or business, or between such places: cf Lunney v Commissioner of Taxation (1958) 100 CLR 478. In the present case, however, Spassked relies on what it says was an expected receipt of dividends on its "A" shares in GIH which did not eventuate. In these circumstances, it may be all the more readily seen that the "connection" question is one of the purpose of the borrowing. Senior counsel for Spassked said that Spassked's case was primarily, though not exclusively, one under the second, rather than the first, positive limb of subs 51(1), that is to say, a case that the interest expense of $888,165,526 was "necessarily incurred in carrying on a business [of a holding company] for the purpose of gaining or producing [assessable] income" (my emphasis). 169 The word "necessarily" in the second positive limb does not mean "indispensably" or "requisitely", but "appropriately" or "aptly": Ronpibon at 56; Federal Commissioner of Taxation v Snowden & Wilson Pty Ltd (1958) 99 CLR 431 at 436-437 per Dixon CJ.

Holding companies 170 In the present case, the second positive limb of subs 51(1) raises a question as to the business of a holding company. The word "business" was defined in subs 6(1) of the Act to include "any profession, trade, employment, vocation or calling but ... not ... occupation as an employee". The definition is of no present assistance. 171 Spassked was a holding company - an intermediate holding company in the IEL Group. Regarded as a whole, the IEL Group was engaged in the business of investment (in a broad sense) in other existing businesses, and it may be taken that in various ways all the members of the Group, including Spassked, served that end. Against this background, senior counsel for Spassked relies on the discussion of the business of a holding company in Brookton Co-operative Society Ltd v Commissioner of Taxation (1981) 147 CLR 441. In that case the taxpayer was a company incorporated under the Co-operation Act 1923 (NSW). By a pre-arranged series of transactions, the company was given shares in other companies, and it subsequently received dividends on those shares. The High Court was unanimous in holding that the taxpayer was not: "established for the purpose of carrying on any business having as its primary object or objects one or more of the following:- ... (d) the rendering of services to its shareholders" for the purposes of the definition of "co-operative company" in subs 117(1) of the Act. 172 Aickin J stated (at 469-470): "There remains the question whether the taxpayer carried on another business in addition to providing services to its members. Its activities (to use a neutral term) have been described above and in the reasons for judgment of my brother Mason. Do they amount to carrying on a business? Generally speaking it is a question of fact whether what an individual or a company does constitutes carrying on a business. It has often been said that it is easier to draw an inference that an income earning activity of a company is a business than to do so when the same activity is undertaken by an individual; see, eg, the observations of Lord Diplock delivering the advice of the Privy Council in American Leaf Blending Co Sdn Bhd v Director-General of Inland Revenue (Malaysia) [[1979] AC 676, at 684]. That was a case of a company which had closed down its tobacco business and thereafter let its premises and received the rent therefrom. In the case of a company which had no activity other than receipt of dividends from shares which it had purchased, it would ordinarily be regarded as carrying on a business even if it did not actively manage its portfolio of investments, though an individual who did the same would not necessarily be regarded as carrying on such a business; cp. Esquire Nominees Ltd v Federal Commissioner of Taxation [(1973) 129 CLR at 212] per Barwick CJ and [(1973) 129 CLR at 221] Menzies J. The present case presents the unusual feature that the taxpayer did not employ its own funds or borrowed funds in acquiring its shareholding in each of its subsidiaries. Indeed the Co-operation Act prohibited it from so doing. It became a shareholder in those companies as the recipient of gifts from other companies controlled by three of its directors in the manner described above. This does not mean that the taxpayer was entirely passive for its directors resolved to accept each gift and executed the various transfers under its common seal in respect of each of the gifts, including the transfer by one of its subsidiaries of shares in its sub-subsidiaries. It is perhaps not surprising that there appears to be no authority dealing expressly with such a situation. It is hard to visualize a situation in which the holding of and receipt of dividends from, shares the subject of a gift by an individual would be regarded as the carrying on of a business. However a company stands in a different position for most companies are formed for the purpose of carrying on business and having the capacity to carry on business; the taxpayer was certainly so formed. All these circumstances, including the repetition of acceptance of gifts of shares constituted activities of a business character designed and intended to obtain a business advantage for the taxpayer, ie, the acquisition of income-earning assets for the receipt of dividends must have been expected by at least some of its directors, and one would expect that the other directors were informed. It was no doubt a set of unusual transactions but it improved the capital structure of the taxpayer and gave it a prospect, if not a probability, of receiving amounts of income. In my opinion the acquisition of these shares and their retention were business activities and constituted the carrying on of the business of holding investments in the expectation of receiving dividends, notwithstanding that the shares in question were received by way of gift. Such a business however is not within the categories set out in s 117(1) of the Act." 173 With respect, I do not think his Honour's observations set out above assist Spassked. While the reasoning of Aickin J might be inconsistent with a submission that Spassked was not carrying on a business because its only relevant activity consisted of making a series of borrowings from IEF followed by subscriptions for shares in a subsidiary, that is not the Commissioner's submission. The Commissioner's submission is that it is the absence of the purpose of the borrowing of deriving dividends that leads to the conclusion that the interest expenses were not incurred "in carrying on a business for the purpose of gaining or producing [the assessable] income." (my emphasis) 174 Spassked also relies on Federal Commissioner of Taxation v Total Holdings (Australia) Pty Ltd (1979) 43 FLR 217 ("Total"), another holding company case. In Total Lockhart J (with whom Northrop and Fisher JJ agreed) stated (at 223-224): "If a liability for interest is incurred for the purpose of introducing capital into an income gaining business, the payment of interest is allowable as a deduction: see Federal Commissioner of Taxation v Munro [(1926) 38 CLR 153 at 171, 197, 217-218]; Texas Co (Australasia) Ltd v Federal Commissioner of Taxation per Latham CJ [(1940) 63 CLR 382 at 430] and per Dixon J where his Honour said: 'Some kinds of recurrent expenditure made to secure capital or working capital are clearly deductible. Under the Australian system, interest on money borrowed for the purpose forms a deduction. So does the rent of premises and the hire of plant' [(1940) 63 CLR 382 at 468]." A little later, Lockhart J said (at 224): "In my opinion if a taxpayer incurs a recurrent liability for interest for the purpose of furthering his present or prospective income-producing activities, whether those activities are properly characterized as the carrying on of a business or not, generally the payment by him of that interest will be an allowable deduction under s 51: [his Honour cited authorities]." But again the "income gaining" nature of the business and "the purpose of furthering [the taxpayer's] present or prospective income-producing activities" are insisted upon. As Lockhart J recognised in Total, "[t]he question whether interest [one may interpolate 'incurred by a holding company'] is actually incurred in gaining or producing assessable income is one mainly of fact" (at 223). 175 The Commissioner issued Income Tax Ruling IT 2606 dated 16 August 1990, headed "Income Tax: Deductions for Interest on Borrowings to Fund Share Acquisitions", accepting that "the principle stated by Lockhart J in Total Holdings is correct in law", and stating: "In some cases there may be evidence of a policy or plan that the borrower company not receive dividend income at least until its loan had been discharged. Such a policy may have been designed to overcome the operation of the former subsec. 46(7) of the Act and thereby achieve the full tax benefit of both the interest deduction and the inter-company dividend rebate by ensuring the interest deduction was not set off against dividend income (see Taxation Ruling IT 2605). Despite the deferral of the receipt of income a deduction would still be allowable under the first limb of subsection 51(1) provided there was always an expectation and intention as well as the potential for dividends to be paid to the borrower company, albeit in the long term (Ronpibon Tin NL v FC of T (1949) 78 CLR 47 at p 57, Total Holdings). Whether such intention and potential exists is a question of fact to be decided having regard to all the objective circumstances in each particular case. In this regard evidence as to purpose may be relevant. For the reasons outlined earlier in this Ruling, a deduction may in any event be allowable under the second limb of subsec. 51(1) in such cases." (my emphasis) As in Ronpibon, the reference to "expectation" must not be read out of context. The context here includes the earlier reference to "a policy or plan" and the conjunction of the word "expectation" with "intention". The occasion, purpose or explanation of the borrowing must be the derivation of dividend income, even if deferred. 176 Federal Commissioner of Taxation v EA Marr and Sons (Sales) Ltd (1984) 84 ATC 4580, like the present case, concerned an intermediate holding company in a group of companies. The facts were somewhat complex. The taxpayer and its subsidiaries constituted one of three divisions of the McDonald Industries Group, the ultimate holding company of which was McDonald Industries Ltd, a listed public company. The taxpayer's division was "the machinery and plant division". The taxpayer engaged in a range of activities directed to deriving various kinds of "fees" from its subsidiaries and from other members of the McDonald Industries Group, and its business included the leasing of land and buildings to its subsidiaries for which it received rental. The subsidiaries derived income from leasing out the equipment, but did not pay dividends to the taxpayer. 177 The taxpayer leased the equipment from finance companies and made it available to its subsidiaries rent free but on the basis that they would pay the rent to the finance companies. No formal instruments of sub-lease were entered into. For a time the subsidiaries paid the rent to the finance companies. Receivers were appointed to the taxpayer. During the receivership the taxpayer continued to carry on business. 178 A Full Court of this Court upheld the trial Judge's decision that rent paid by the taxpayer to the finance companies was an allowable deduction. Central to this result was their Honours' conclusion that the leasing and "sub-leasing" was not a separate business but a part of a broader business of the taxpayer from which it did derive assessable income. In substance, the making available of the equipment to its subsidiaries, albeit rent free, was one of a range of services the taxpayer provided to them in the course of carrying on its business for the purpose of deriving various forms of income from them. 179 Their Honours stated (at 4584-4585): "It is true that the arrangements between the taxpayer and its subsidiaries for the use of the leased plant were very informal. There were, for example, no formal instruments of reletting or rehiring. It is also true that no income was derived by the taxpayer from its leasing activities in question here, at least until after the appointment of the receivers. The first, and usually the second, rental payments due by the taxpayer to the finance companies were paid by it and it was reimbursed by the subsidiary concerned. Thereafter the subsidiaries paid the rental payments due by the taxpayer direct to the finance companies. But the subsidiaries were all wholly owned by the taxpayer. It controlled their activities and was in a position to channel their resources in whatever direction it wished. Although the subsidiaries did not pay rental to the taxpayer under the subleases (if that be the correct description of the arrangement between them), they in turn relet the leased plant to generate profits or used it in their own businesses. The taxpayer could, if and when it wished, direct profits from its subsidiaries to itself, for example, by having the subsidiary declare dividends. There is also some evidence that the taxpayer hoped to derive profit from this leasing activity in question in the long term. The taxpayer's public company status for income tax purposes ensured that no income tax liability would be borne by it if this was done. Doubtless, in selecting which subsidiaries should have the use of the leased plant an important consideration was which of them would incur the least liability for income tax arising out of the receipt of hiring charges from the person to whom the plant was ultimately hired. By not requiring its subsidiaries to return profits to it, the taxpayer was in effect allowing them to build up and improve their capacity to do so. It is one way whereby a parent may give working capital to its subsidiary." The present case is distinguishable. IEL was also a shareholder in GIH and Spassked was a wholly owned subsidiary of IEL. Ultimately, IEL, not Spassked, had the capacity to control GIH's dividend policy. Moreover, there were not benefits other than dividends moving from GIH to Spassked to be taken into account. 180 In any event, the relevance of the passage set out above to the present case depends on the facts of the present case as I will find them to be. My finding will not be that Spassked "hoped to derive profit from [its borrowing from IEF and investing in GIH] activity."

Subjective and objective expectations and purposes 181 In a case such as the present one, turning not on the actual receipt of relevant assessable income, there may be a stronger inclination than in other cases to resort to the subjective expectation or purpose of the taxpayer. In my opinion, however, ultimately the significance of the word "in" in both positive limbs is objective. But this does not mean that motivation or subjective purpose is necessarily irrelevant to the identification of the purpose which characterised incurrence of the loss or outgoing (first limb) or the business (second limb). 182 The appropriateness of regarding the motivation or subjective purpose of the taxpayer was debated before me. In Fletcher all seven Judges of the High Court, in a joint judgment, discussed the matter in the context of a taxpayer's claimed deduction of interest on money borrowed and an actual receipt of assessable income. Their Honours stated (at 17-19 - footnotes and references to them are omitted): "The question whether an outgoing was, for the purposes of s 51(1), wholly or partly 'incurred in gaining or producing the assessable income' is a question of characterisation. The relationship between the outgoing and the assessable income must be such as to impart to the outgoing the character of an outgoing of the relevant kind. It has been pointed out on many occasions in the cases that an outgoing will not properly be characterised as having been incurred in gaining or producing assessable income unless it was 'incidental and relevant to that end'. It has also been said that the test of deductibility under the first limb of s 51(1) is that 'it is both sufficient and necessary that the occasion of the loss or outgoing should be found in whatever is productive of the assessable income or, if none be produced, would be expected to produce assessable income'. So to say is not, however, to exclude the motive of the taxpayer in making the outgoing as a possibly relevant factor in characterisation for the purposes of the first limb of s 51(1). At least in a case where the outgoing has been voluntarily incurred, the end which the taxpayer subjectively had in view in incurring it may, depending upon the circumstances of the particular case, constitute an element, and possibly the decisive element, in characterisation of either the whole or part of the outgoing for the purposes of the sub-section. In that regard and in the context of the sub-section's clear contemplation of apportionment, statements in the cases to the effect that it is sufficient for the purposes of s 51(1) that the production of assessable income is 'the occasion' of the outgoing or that the outgoing is a 'cost of a step taken in the process of gaining or producing income' are to be understood as referring to a genuine and not colourable relationship between the whole of the expenditure and the production of such income. Nonetheless, it is commonly possible to characterise an outgoing as being wholly of the kind referred to in the first limb of s 51(1) without any need to refer to the taxpayer's subjective thought processes. That is ordinarily so in a case where the outgoing gives rise to the receipt of a larger amount of assessable income. In such a case, the characterisation of the particular outgoing as wholly of a kind referred to in s 51(1) will ordinarily not be affected by considerations of the taxpayer's subjective motivation. If, for example, a particular item of assessable income can be earned by making a lesser outgoing in one of two possible ways, one of which is a loss or outgoing of the kind described in s 51(1) and the other of which is not, it will ordinarily be irrelevant that the taxpayer's choice of the method which was tax deductible was motivated by taxation considerations or that the non-deductible outgoing would have been less than the deductible one. In such a case, the objective relationship between the outgoing actually made and the greater amount of assessable income actually earned suffices, without more, to characterise the whole outgoing as one which was incurred in gaining or producing assessable income. If the outgoing can properly be wholly so characterised, it 'is not for the Court or the commissioner to say how much a taxpayer ought to spend in obtaining his income, but only how much he has spent'. The position may, however, well be different in a case where no relevant assessable income can be identified or where the relevant assessable income is less than the amount of the outgoing. Even in a case where some assessable income is derived as a result of the outgoing, the disproportion between the detriment of the outgoing and the benefit of the income may give rise to a need to resolve the problem of characterisation of the outgoing for the purposes of the sub-section by a weighing of the various aspects of the whole set of circumstances, including direct and indirect objects and advantages which the taxpayer sought in making the outgoing. Where that is so, it is a 'commonsense' or 'practical' weighing of all the factors which must provide the ultimate answer. If, upon consideration of all those factors, it appears that, notwithstanding the disproportion between outgoing and income, the whole outgoing is properly to be characterised as genuinely and not colourably incurred in gaining or producing assessable income, the entire outgoing will fall within the first limb of s 51(1) unless it is either somehow excluded by the exception of 'outgoings of capital, or of a capital, private or domestic nature' or 'incurred in relation to the gaining or production of exempt income'. If, however, that consideration reveals that the disproportion between outgoing and relevant assessable income is essentially to be explained by reference to the independent pursuit of some other objective and that part only of the outgoing can be characterised by reference to the actual or expected production of assessable income, apportionment of the outgoing between the pursuit of assessable income and the pursuit of that other objective will be necessary." (my emphasis)

In sum, objective circumstances alone, notably the amount of the outgoing and the greater amount of the assessable income received, may establish the connection required by the word "in" in the first positive limb, but if not, the taxpayer's motivation and other circumstances may do so. (Two men in business suits catch a bus to the same destination for the same fare: testimony as to subjective purpose is admissible to show that one is on business in pursuit of assessable income and is entitled to a deduction for the fare, but that the other is on the way to a place of worship and is not so entitled!)

183 I do not accept Spassked's submission that it is sufficient that: · Spassked was a parent company; · the monies it borrowed from IEF were invested in its subsidiary, GIH; and · there was a possibility that as a result of the investment, dividends would be streamed up from the Subcos, through GIH, to Spassked.

I am not bound to find that Spassked borrowed from IEF at interest and thus incurred the resulting interest expenses in gaining or producing assessable income, or in carrying on a business for the purpose of doing so, by reason of nothing more than that formal legal possibility: cf Ure v Federal Commissioner of Taxation (1981) 50 FLR 219, a case under the first positive limb. References in the cases to expectations, potentials and prospects are not intended to signify that free standing bare possibilities will suffice: rather, they must constitute the taxpayer's purpose. 184 The same individuals were the directors of IEF, Spassked, GIH and many of the Subcos. All those companies were members of the IEL Group. In the years of income 1988 to 1990 Spassked borrowed from IEF, on ten occasions, amounts totalling $3,737,142,866 at interest, and invested in GIH without any return other than one unfranked dividend of $29,308,093 paid on 30 June 1990. Over the succeeding years of income 1991 to 1994 the amounts so borrowed were allowed to remain owing, accruing interest without any return other than one unfranked dividend of $14,654,046 paid on 8 October 1991. The interest for 1992 of $888,165,526 was one of seven annual amounts of capitalised interest totalling $3,272,715,111 which Spassked incurred to IEF over the years 1988 to 1994 (see [107] earlier) on the borrowings of $3,737,142,866 (see [100] earlier). Although it used nearly the whole of this amount (see [102] earlier) in subscribing for shares in GIH, Spassked received two comparatively miniscule dividends totalling only $43,962,139. 185 I am not prepared, on the basis of these circumstances alone, to conclude that it is an adequate description of the interest totalling $3,272,715,111, and therefore of the interest of $888,165,526 incurred in the 1992 year, to say that it was incurred in gaining or producing dividend income from GIH, or that it was necessarily incurred in carrying on a business for the purpose of doing so. The disproportion in the present case is of the kind that their Honours had in mind in the passage from Fletcher set out at [182] above. 186 It is not a material distinction, in the circumstances of the present case, particularly those referred to at [184] above, that in Fletcher their Honours were contemplating a return in the form of a low rate of interest or a low rate of rent, whereas the present case involves a low rate of dividend. It is not suggested that the dividends paid by GIH to Spassked were unexpectedly low because of market reversals affecting the underlying investments. In fact, over the years of income 1988 to 1994, the Subcos received unfranked dividends totalling $1,454,337,884 ($316,127,089 over the years 1988 to 1990) and franked dividends totalling $83,495,197 ($79,222,958 over the years 1988 to 1990). Over the years of income 1988 to 1994, GIH received from the Subcos unfranked dividends totalling $226,711,527 ($187,955,421 over the years 1988 to 1990) and franked dividends totalling $33,378,831 (all of them in the years 1988 to 1990).

Tax considerations as a motive 187 Spassked relies on the following observations made in relation to Fletcher by a Full Court of this Court in Service v Commissioner of Taxation (2000) 97 FCR 265 ("Service") at 278-280: "There is no reference in that part of the subsection with which the present appeal is concerned [the first positive limb of subs 51(1)] to 'purpose'. This is not to say that the purpose for which the expenditure was incurred is necessarily irrelevant: Fletcher v Commissioner of Taxation at 17-18. We shall return to that case later. It suffices to say that purpose may, in a particular case be relevant to the question of the characterisation of the expenditure. Generally, however, when cases such as Lunney [a reference to Lunney v Commissioner of Taxation (1958) 100 CLR 478] have referred to characterisation, the reference has been to the objective characterisation of the expenditure. The relationship between objective and subjective purpose has been considered by a Full Court of this Court in Magna Alloys & Research Pty Ltd v Commissioner of Taxation (Cth) (1980) 49 FLR 183. In that case Deane and Fisher JJ expressed a twofold test in the following terms (at 210): '… whether the outgoing was reasonably capable of being seen as desirable or appropriate from the point of view of the pursuit of the business ends of that business and, if so, whether those responsible for carrying on the business so saw it.' Although their Honours were writing of the second (business) limb of the subsection, there seems no reason to believe that what they said would not apply to the first (income production) limb. So, in Magna Alloys, the fact that the directors of a company caused the company to incur expenditure with the dominant motive of protecting their own position, rather than for the benefit of the company, did not preclude deductibility where objectively the expenditure was reasonably capable of being seen as appropriate for the business ends of the company and was so seen by the directors. It would follow from Magna that the fact that expenditure was incurred in circumstances where a taxpayer had as a purpose, or even a dominant purpose, the purpose of reducing tax the expenditure would be deductible, so long as objectively the outgoing was reasonably capable of being seen as directed towards the gaining and production of assessable income and was so seen by the taxpayer. Section 51(1) is not a section as such directed at tax avoidance. There is a specific part of the Act (Pt IVA) which can operate to disallow as a deduction expenditure which otherwise qualifies as a deduction under s 51(1). If s 51(1) operated to disallow a deduction in circumstances where there was a purpose of avoiding tax or even a dominant purpose of avoiding tax then Pt IVA would have no operation to the case of a deduction otherwise allowable under s 51(1). However there is no suggestion that Pt IVA has no operation in such a case. So, as the High Court pointed out in John v Commissioner of Taxation (1989) 166 CLR 417, the finding that an outgoing was for trading stock and was incurred in carrying on a business for the purpose of gaining or producing assessable income denied the possibility that the outgoing was private expenditure and not deductible, even where the arrangement in question was instigated to obtain a tax advantage.

However, this is not to say that purpose is irrelevant to the question of characterisation, that is to say irrelevant to the question whether the outgoing was incurred in gaining or producing assessable income. Where a taxpayer borrows at a normal rate of interest but lends at a low rate of interest to persons related to him or her and thereby seeks a deduction the objective circumstances characterise the expenditure as not in whole incurred in gaining or producing the assessable income, in that case the low rate of interest: Ure v Commissioner of Taxation (Cth) (1981) 50 FLR 219. Also see, in the analogous case of premises rented at a low rate of rent: Madigan v Commissioner of Taxation (Cth) (1996) 68 FCR 12. In these cases only a proportion of the outgoing was allowed as a deduction, the subsection permitting of apportionment. It is clear from these cases, as we have already pointed out, and in particular from Fletcher, that subjective purpose will have in some cases, at least, a role in the question of characterisation, that is to say a role in determining whether the loss or outgoing is incurred in gaining or producing the assessable income. In Fletcher Mason CJ, Brennan, Deane, Dawson, Toohey, Gaudron and McHugh JJ pointed out that it will be commonly possible to characterise an outgoing as being wholly of a kind falling within the subsection without reference to subjective purpose or motives. Their Honours said [there followed passages from p 18 of Fletcher set out at [182] above]. … It may be noted that their Honours express themselves in language that makes it clear that it will be only where the circumstances are such that the outgoing is only colourably and not genuinely incurred in gaining or producing assessable income that issues of disallowance of the deduction in whole or in part will arise. That, on its face, may well have been the case in Fletcher. A result of the arrangement, which involved the taxpayers borrowing, at interest (payable upfront), large amounts to purchase an annuity substantially payable in the future was that the taxpayers claimed a large deduction at the commencement of the arrangement and, assuming the arrangement proceeded, only derived income a long way in the future. However, the arrangement included a mechanism whereby it could be aborted and no income at all derived. It is for that reason that the Court stated the issue of fact, left undetermined in that case, to be whether the outgoings were incurred in the expectation that the plan would run its course, or whether it was the intention of any relevant person that the scheme be aborted. The judgment of the Court makes clear that if the expectation was that the plan would run its course then the deduction would (subject to the anti-avoidance provisions of the Act) be available. This would follow, notwithstanding that there was an obvious tax advantage to the taxpayers, and the inference would have been inescapable that the taxpayers were motivated by this tax advantage to enter into the arrangement. It is significant that the High Court did not direct an inquiry into whether the taxpayers were motivated in whole or in part by tax considerations. Rather the enquiry was directed towards whether the arrangement was one where no assessable income would be derived in the later years." 188 Clearly, it does not make the interest expenses non-deductible that the motive or subjective purpose of the directors of Spassked and IEF (the same persons) was to minimise the tax payable by the IEL Group: see, in addition to Service, Magna Alloys and Research Pty Ltd v Federal Commissioner of Taxation (1980) 49 FLR 183 ("Magna Alloys") at 196; John v Commissioner of Taxation (1989) 166 CLR 417 at 434-435; Commissioner of Taxation v Spotless Services Ltd (1996) 186 CLR 404 at 415-416; Hart at 4617 per Hill J. But a finding of that motivation or subjective purpose might be relevant to any attempt by Spassked to prove the different motivation or subjective purpose of deriving dividend income from GIH. 189 In the present case in which, as I have concluded earlier, the objective circumstances of the relationships between IEF, Spassked, GIH and the Subcos, the common memberships of their boards of directors (in the case of the Subcos, of many but not all of them), the amounts borrowed, the amounts of interest incurred and the amounts of dividends received, standing alone do not satisfy me that the interest expenses were incurred by Spassked in gaining or producing dividend income from GIH, or necessarily incurred in carrying on a business for the purpose of doing so, it is open to me to take into account, as one relevant factor in Spassked's favour, its motivation or subjective purpose. 190 In conformity with Fletcher, Spassked proffered evidence of the subjective expectations of Daniels, a director of Spassked. Daniels' testimony as to his subjective expectations is to be taken into account, as is evidence tending against his testimony, but the ultimate question remains the objective one whether the interest expense was incurred in gaining or producing the assessable income, or was necessarily incurred in carrying on a business for the purpose of gaining or producing the assessable income.

Magna Alloys 191 In Magna Alloys, Deane and Fisher JJ proposed the following test (at 210): " ... Whether a voluntary outgoing was so incurred [that is, necessarily incurred in carrying on a business for the purposes of s 51(1)] depends upon the answer to the composite question ... whether the outgoing was reasonably capable of being seen as desirable or appropriate from the point of view of the pursuit of the business ends of [the taxpayer's] business and, if so, whether those responsible for carrying on the business so saw it." This statement seems to be applicable, with necessary adjustments, also to the first positive limb of subs 51(1): cf Hart at 4617 per Hill J. It describes a composite objective and subjective test, which I consider to be applicable in the present case. But I would add that in a particular case, how those responsible for carrying on a business "saw" the voluntary incurring of an outgoing may be inferred from the objective circumstances.

Steele 192 The borrowing and investment by Spassked is coloured by the fact that it was a member of the IEL Group, that it was being used as part of a restructuring in the interests of the Group as a whole, and that the same persons were the directors of IEF, Spassked, GIH and many of the Subcos. The ten borrowing and investing transactions were not arm's length transactions. Moreover, the case is, like Steele, also a "deductibility of interest" case, in which the taxpayer had a vague general purpose of ultimately using land for a motel development. This did not eventuate and the taxpayer sold the land. Gleeson CJ, Gaudron and Gummow JJ stated (at 475-476): "The respondent placed reliance upon the concept of commitment as an aid to the formation of a factual judgment, in a case such as the present, as to the sufficiency of the relevant connection between outgoing and income. The utility of that concept may vary with the circumstances of individual cases. The views of the majority in the Full Court of the Federal Court on the question are set out above. The present is not a case in which the appellant had in contemplation a variety of alternative possible uses of Tibradden [the subject land], some of an income-producing nature and others not. There was no suggestion, for example, that she ever contemplated using the property for private or domestic purposes. That was never an option. As Carr J [the primary Judge] pointed out, whilst she was not financially committed to a motel development, and had not decided upon any particular development, she does not appear to have envisaged any use of or dealing with the property other than one which would produce assessable income." But in the present case there are explanatory purposes other than the gaining or producing of assessable income that have to be considered.

Spassked's general course of borrowing from IEF 193 As appears in the table at [100] above, the last of Spassked's borrowings from IEF occurred on 28 June 1990. It was on the total amount borrowed, $3,737,142,866 down to that date plus subsequently accrued and capitalised interest, that the 1992 interest of $888,165,526 must have been calculated. The parties proceeded on the basis that no distinction was to be drawn between Spassked's various borrowings from IEF and investments in GIH, or between the various investments by GIH in the Subcos, all over the years 1988-1990, or between the seven annual amounts of capitalised interest for the years 1988-1994 listed in [107] above. Accordingly, I need not distinguish between the various sums borrowed on which the interest accrued, or between the uses to which those sums were put. 194 Nor is it suggested that there was any relevant change of circumstances, including a change in the motivation or the subjective purpose of the directors of Spassked, throughout the three years of income in which the borrowings were made and the borrowed amounts invested in GIH.

Four general matters 195 The following four matters may be noted at the outset. First, on this appeal under s 14ZZ of the Administration Act, Spassked has the burden of proving that the assessment is excessive, that is to say, relevantly, that the interest expense falls within one or both positive limbs of subs 51(1) of the Act: see s 14ZZO(b) of the Administration Act. 196 Secondly, there are no contemporaneous records of the proceedings of the boards of directors of Spassked or of the other relevant members of the Group, such as GIH or IEF. The evidence shows that the lack of "paper work" was due to Brierley's management style. But what matters at present is that Spassked is forced to rely on the recollections of Daniels and Cottam in 2002 of events and states of mind in the second half of 1987. 197 Thirdly, Spassked called only one of the four persons who were directors of it in the period June 1987 to January 1988 when the Spassked Structure was devised, approved and implemented in the first two transactions (it is not suggested that there was any relevant change of circumstances from then down to 28 June 1990, when the tenth and last transaction occurred). The four directors were: Director Appointed Ceased Daniels 17 March 1987 30 June 1994 Price 17 March 1987 21 February 1990 Weiss 17 March 1987 30 September 1988 Ronald Jeremy Lewin 17 March 1987 21 November 1990

The fact that Spassked called only one of those directors, coupled with the absence of contemporaneous records of proceedings of directors, poses a difficulty for it in so far as it may wish to prove its corporate state of mind when borrowing from IEF. While Daniels can give evidence as to what his own state of mind was, I am left to infer what the states of mind of the other directors were from the circumstances proved by his and Cottam's testimony and other evidence. 198 Fourthly, it seemed to me that Daniels and Cottam understood that it was an issue in the case whether Spassked expected to derive dividends from its investment in GIH. As noted earlier, in his main affidavit Daniels was at pains to list his "expectations". Cottam's affidavit also spoke of the advantages he "envisaged" as flowing from the adoption of the Spassked Structure. While neither witness is the taxpayer, the following observations of Fullagar J in Pascoe v Commissioner of Taxation (1956) 30 ALJ 402 at 403 still have some force in the context of the facts of the present case: "Where a person's purpose or object or other state of mind in relation to a given transaction is in issue, the statements of that person in the witness box provide, in a sense, the 'best' evidence, but, for obvious reasons, they must, as Cussen J observed in Cox v Smail ([1912] VLR 274, at p 283), 'be tested most closely, and received with the greatest caution'." The "interest" which Daniels and Cottam have in Spassked's success in the proceeding is not financial but professional: they lent their professional expertise and experience as accountants to the devising and implementation of the Spassked Structure. This, coupled with the long time that has elapsed between the second half of 1987 and April 2002 when they testified, causes me, if not to test their evidence as to their states of mind "most closely" and to receive it "with the greatest caution", at least to consider it carefully in the light of the probabilities otherwise shown to exist.

Particular circumstances 199 The circumstances described in the numbered paragraphs below have varying degrees of relevance to the factual questions: · whether the interest expense was incurred by Spassked, that is, whether Spassked's course of borrowing at interest from IEF was engaged in by Spassked, in gaining or producing assessable income in the form of dividends from GIH; and · whether the interest expense was necessarily incurred, that is, whether Spassked's course of borrowing at interest from IEF was necessarily engaged in, in Spassked's carrying on a business for the purpose of gaining or producing assessable income in the form of dividends from GIH.

The terms of the borrowings were not reduced to writing and were not recorded in the minutes of meetings of the boards of directors of borrower or lender. Such contemporaneous records as exist are, generally speaking, only records of movements of money.

The directors of Spassked, being also the directors of IEF, GIH and most of the Subcos (though not of IEL):

· were in a position, and, I am satisfied, intended, to act in what they perceived to be the interests of the Group as a whole, rather than the specific interests of one or more of the companies of which they were directors; and

· in their capacity as directors of Spassked, borrowed knowing what was to be the destination and use of the money borrowed as well, at least in a general sense, as the destination and use of any income which the deployment of that money would generate, that is, of any dividends the Subcos would receive from the underlying investments.

As noted earlier, since there was no agreed term of any of the ten loans from IEF to Spassked, by implication, they were repayable in full upon demand by IEF, whether with or without the prior giving of reasonable notice. But, again, repayment would not be required unless for some reason this was seen to be in the interests of the Group as a whole.

So long as Spassked was incurring an interest liability to IEF or had undistributed losses, it would not receive dividends from GIH.

As Daniels acknowledged, in view of (4) above, and the fact that Spassked's "A" shares in GIH were its only investments, so long as that situation continued, Spassked would not have the necessary income with which to pay the interest accruing on its borrowings from IEF, which therefore would have to be capitalised. Spassked could therefore be expected to make a loss each year of the order of the amount of the capitalised interest for that year. Except to the extent the losses were transferred by Spassked to other members of the Group, they would accumulate in Spassked.

The streaming up of dividends to IEL could not occur through Spassked while Spassked remained a dividend trap, but it could occur directly through GIH, by reason of IEL's holding of "B" shares in GIH. In fact, in the period 1988 to 1994, $33,378,828 (in franked dividends, representing the total amount of franked dividends received by GIH during that period from the Subcos) was streamed up to IEL in this way.

GIH used the funds received from Spassked (and the $150,000,000 subscribed by IEL for "B" shares in GIH) in subscribing for shares in the Subcos which were:

(a) shelf companies; and (b) already capitalised companies within the Group,

Money paid by GIH to a Subco would be applied by the Subco, first, in discharging any interest bearing debts it owed to companies in the Group, in particular, to IEF. This had the effect, as Daniels acknowledged it was intended to do, of enabling the Subco:

· to stream up to GIH, free of any dividend trap problem, any dividends the Subco received from its underlying investments; and · to enjoy the full s 46 rebate in respect of dividends it received.

(a) Shelf companies referred to in 7(a) above would deposit with IEF at interest the funds they received from GIH, until those funds were required, if they were required at all, to enable the shelf company to make a specific investment.

(b) The already capitalised companies within the Group referred to in 7(b) above would deposit with IEF, at interest, any surplus funds received from GIH remaining after their intercompany debt was paid off as described in (8) above.

Daniels agreed that it was an element of the Spassked Structure that "at least in [the] early years" Spassked would be incurring losses because it would be incurring interest to IEF and would not be receiving income with which to pay that interest, and that Spassked would transfer the resulting losses to other members of the Group.

Daniels said that "the major"reasons for adopting the Spassked Structure in preference to other structures that were considered were that:

· it enabled franked dividends to be streamed up to IEL without being subsumed in a dividend trap;

· it enabled unfranked dividends to be streamed up to GIH without being subsumed in a dividend trap; and

· it enabled maximisation of the amounts of losses available to be transferred to members of the Group.

Daniels said that there were three other reasons which were not "critical", and which would not themselves have led to the Spassked Restructuring, but which were considered "as part of the structure". They were that:

· pre-capitalised shelf companies would be readily available as and when required, through which acquisitions or other investments could be made;

· the Group would be rid of "pockets of non-wholly owned companies" and any associated problem for "grouping for section 80 purposes";

· the possibility would be opened up that "the company owning an asset [might] be sold in lieu of the asset which may yield a higher cost base for tax purposes".

Daniels agreed that as events transpired, generally, advantage was not taken of the first and third of these matters, that is, most of the shelf companies capitalised by GIH in January 1988 were not in fact used to acquire external assets, and in all cases underlying assets were sold rather than the companies owing them.

Importantly, neither Daniels nor Cottam suggested that the derivation of dividend income from GIH formed any part of the motivation behind the Spassked Restructuring: rather, Spassked's case is that it was expected as a matter of neutral fact that at some time in the future dividends would begin to flow to it from GIH. As I have indicated earlier, in my opinion this is not sufficient to bring a loss or outgoing within subs 51(1).

Progressively down to 1998, Spassked transferred out to members of the Group all of its tax losses amounting to some $3.2 billion to be applied against their otherwise taxable incomes, that is to say, income against the tax on which no rebate under s 46 of the Act was to be applied. Daniels agreed that "the reason for making the losses …, for transferring the losses [pursuant to s 80G of the Act], was to reduce the amount of tax that the other members of the group would otherwise have had to pay."

It was to be expected and was in fact expected, by Spassked's directors, that the Subcos would receive substantial dividend income from the underlying investments. Over the 1988-1994 financial years, the Subcos received approximately $83.4 million of franked dividends and approximately $1.454 billion of unfranked dividends. Because the Subcos had been rendered clear of debts and associated interest liabilities, those dividends were not subsumed in dividend traps at the Subco level. What happened to those funds? As previously noted, GIH paid to IEL franked dividends totalling $33,378,828 (the amount of franked dividends GIH itself had received from the Subcos), and to Spassked the two unfranked dividends totalling $43,962,139 previously mentioned. This left GIH holding a balance of $182,749,388 of unfranked dividends it had received from the Subcos available for streaming up to Spassked, but not in fact streamed up to it. But perhaps more significantly, the Subcos were left holding some $50 million of franked dividends and some $1.227 billion of unfranked dividends which, so far as GIH's articles of association were concerned, could have been streamed up to GIH and thence to Spassked and (in the case of franked dividends only) to IEL. There would be no streaming up of dividends to Spassked so long as it was a dividend trap and still had transferable losses. In relation to the latter, the Commissioner submits as follows:

"The importance to the IEL group of maximising the tax losses is illustrated by the impact of the losses on the total taxation position of the members of the group. In the year of income ended 30 June 1991 the total taxable income of the IEL group was $1,309,955,903.00 (before the transfer of losses), $162,665,425.00 of which represented rebateable dividends … After allowing for the rebateable dividends, the resulting total taxable income was $1,147,685,524.00. This figure was reduced to $5,460,747.00 by the transfer of tax losses in the sum of $1,142,224,777.00. Spassked's contribution to these losses was $642,273,167.00. In the year of income ended 30 June 1992, the total taxable income of the IEL group (before the transfer of losses) was $4,045,564,415.00, $2,860,074,321.00 of which represented rebateable dividends. After allowing for the rebateable dividends, the resulting total taxable income was $1,181,494,467.00. This figure was reduced to $699,872.00 by the transfer of tax losses of $1,180,794,595. Spassked's contribution to the transfer of losses was $800,415,065.00. In the year of income ended 30 June 1993, the total taxable income of the IEL group (before the transfer of losses) was $676,949,195. After allowing for the rateable dividends, the resulting total taxable income was $430,708,195. This figure was reduced to nil by the transfer of tax losses. Spassked's contribution to the transfer of losses was $200,917,810 ... "

Daniels, said of Spassked's ceasing to be a dividend trap and a repository of losses, "the two go together. It cease[s] to be a dividend trap. It ceases to be a borrower. It ceases to have interest deductions."

It was the Administration Team and the tax division within the Group (in particular, Daniels and Latham), not the Investment Team, which perceived a restructuring of the Group to be desirable and initiated exploration of the question.

Similarly, while Price approved of the Spassked Structure, it was the Administration Team (notably Latham and Cottam), not the Investment Team, which determined the timing and amounts of the transactions by which the Spassked Structure was implemented.

Nonetheless, there was a "very strong desire" on the part of the Investment Team that IEL be in a position to receive franked dividends and pass them on to its shareholders. But any incurring of interest in any company down the line from IEL would impede the flow of such dividends up to it.

Daniels said that to the extent that a liability to pay interest down the line constituted an impediment to the free flow of dividends up to IEL, "there was a necessity to try and improve that situation".

I am not persuaded that simplification of the complex debt and equity lines within the Group explains the Spassked Restructuring. Overall, those lines appear to have remained as complex afterwards as they were before. The Spassked Structure may have had simpler debt and equity lines than alternative forms of restructuring that were being considered, but that is a different matter. In any event, a motive of simplification of debt and equity lines does not assist Spassked in relation to the issues under subs 51(1).

I am satisfied that the dominant motivation for the Spassked Structure was to be found in the following interrelated considerations: · the removal of many dividend traps in the Group in favour of one large dividend trap (Spassked) which could be sidestepped, so that dividends, whether franked or unfranked, could be streamed up to GIH and franked dividends paid to IEL;

· ensuring the availability of s 46 tax rebates; and

· the concentration of all transferable tax losses in a single company in the Group (Spassked). But this alone does not signify that the interest expense lay outside the terms of subs 51(1): consistently with the subjective motivation described, the borrowings might also have been explained by an expectation (in the positive sense explained at [164]-[166]) or purpose of gaining or producing assessable income.

The dispute with the ATO did not arise before early 1991 and did not affect the decision of GIH whether to pay a dividend to Spassked in the years ended 30 June 1988, 1989 and 1990. Moreover, Daniels conceded that it would not have affected that decision in respect of the year ended 30 June 1991 to the same extent as it did later years. Quite apart from the tax dispute with the ATO, GIH would have continued not to pay dividends to Spassked because Spassked remained a dividend trap, and did so, as Daniels agreed, at least until he left IEL on 30 June 1994.

Spassked was the only shareholder in GIH entitled to unfranked dividends. It follows that, unless GIH's articles of association were altered:

· if there was an expectation or purpose that Spassked would cease to be a dividend trap and a repository of losses and that GIH would then pay unfranked dividends, there was an expectation or purpose that payment of them would be made to Spassked; and · if the facts suggest that GIH intended to pay unfranked dividends, they suggest that it intended to pay them to Spassked.

But I am not satisfied that any such expectation, purpose or intention existed. It must not be overlooked that it was open to GIH, if it wished to upstream unfranked dividends it had received from the Subcos, to pay the relevant tax and pay franked dividends to IEL. That is, in effect, it was possible, by paying the relevant tax to "convert" incoming unfranked dividends into outgoing franked dividends.

The question of expectation (in the positive sense explained at [164]-[166]) or purpose to be determined as at mid 1987 to 28 June 1990

200 I proceed now to consider the question whether, when Spassked incurred the interest expense of $888,165,526 to IEF in 1992, there was an expectation (in the positive sense explained at [164]-[166]) or purpose that Spassked would cease to be a dividend trap and repository of transferable losses, and would then commence receiving dividends from GIH. The Spassked Structure was devised in the latter half of 1987 and approved in December 1987. The ten borrowings from IEF on which that interest accrued were made from 30 December 1987 to 28 June 1990 (see [100] earlier). Did that expectation or purpose exist at those times (as noted earlier, there is no suggestion of any change of expectation or purpose in the three year period from mid 1987 to 28 June 1990)?

Testimony of Daniels and Cottam 201 I am clearly satisfied, on the basis of the testimony of Daniels and Cottam: · that there was no agreed plan, mechanism or time frame, according to which Spassked would cease to be a dividend trap, cease to be a repository of losses, and begin to receive dividends from GIH; · that the receipt by Spassked of dividends from GIH formed no part of the motivation, subjective purpose or impetus behind the Spassked Restructuring. The testimony of Daniels and Cottam, properly understood, is rather directed to what they expected would, as a matter of fact, eventuate, and, as will be seen, I do not find their testimony even in this respect entirely persuasive. 202 Neither Daniels nor Cottam volunteered in his affidavit testimony that the Spassked Structure was to have a particular lifetime, that is, a particular time or estimated time after which Spassked would cease incurring interest expenses to IEF and cease having losses transferable to members of the Group. Daniels stated, however, in his first affidavit: "62. I expected GIH would use the funds obtained from Spassked to invest in subsidiaries. I expected the subsidiaries would own, or acquire, income-producing assets or trading companies. I also expected that the subsidiaries in turn, would pay dividends up to GIH as each of their investments matured. Based on the quality of assets or trading companies which I expected the GIH subsidiaries to own or invest in, I did not doubt that the GIH subsidiaries would, upon maturity of their investments, pay dividends up to GIH, to enable GIH to deliver a return to its shareholders, Spassked, and IEL. 63. I expected Spassked would receive dividends from GIH once its investments in underlying subsidiaries began to mature, and produce a fund of profits from which dividends could be paid. With the quantum and quality of assets that GIH would be expected to acquire through its investments in subsidiaries, I did not doubt that GIH would be in a position to pay dividends to Spassked. I expected that Spassked would ultimately pass dividends up to IEL, once Spassked ceased to be a dividend trap. 64. I expected that any investment in GIH by Spassked would be assessed by the directors of Spassked taking a portfolio approach. By "portfolio approach", I mean that the decision to invest in GIH would be based upon consideration of the Spassked group as a whole. It would take account of the diversity of investments and assets which I expected the Spassked group would eventually own, each with different risk profiles and earnings potential. I expected some companies may be in a loss situation while the majority may be profitable. It would depend upon the nature of the underlying investments in question, and the extent to which they had matured and were capable of generating income. It was my expectation, based upon my experience of the IEL group's development and growth generally that overall profits within the Spassked group would significantly exceed losses. … 70. I expected that the future investment activities of the Spassked group would yield a commercial return greater than the borrowing costs incurred by Spassked itself. My expectation was based on the quality of investments which I expected the group to make, and the investment track record of the IEL group over the many years of my employment (see the table at paragraph 40 of this Affidavit [a reference to the table at [72] above]). This illustrates that IEL's after tax returns on investment for the years of income ending 30 June 1984 to 30 June 1986 inclusive ranged from 25.1% to 29.7%, per annum). I did, however, take into account the moderating effects of the stock market crash in October 1987 in forming my expectations. I nevertheless expected that reasonable returns upon the Spassked group investments, significantly in excess of Spassked group costs and expenses, would materialise." (my emphasis)

It will be recalled also that Daniels said he expected that GIH would not pay dividends to Spassked "piecemeal" but that it would pay one large dividend at the beginning of a year of income sufficient to eliminate Spassked's debt of principal and capitalised interest to IEF, and that this radical change of circumstances would occur in the "medium" term.

203 For his part, Cottam agreed in cross-examination that: "the reason for putting in Spassked and GIH below IEL and having the funding go to Spassked was so that, when dividends were declared up from the subcompany, they need not be declared into a company which had the interest expense."

Like Daniels, Cottam accepted that GIH would not pay dividends to Spassked so long as Spassked was a dividend trap and had tax losses - "[u]ntil such time as [it was] unwound". Cottam explained that by "unwound" he meant to refer to a sale of assets by the Subcos and return of capital and payment of dividends up the line, including to Spassked. Asked whether there was discussion in the latter half of 1987 as to the time frame for that to occur, Cottam simply said "It was sort of a five to ten year affair". Asked whether there had been discussion as to whether payment would be made by way of dividend, or return of capital on a liquidation, or a lending back, Cottam again did not answer the question straightforwardly. His statement and the cross-examination which followed it were as follows: "I think we knew it would find its way somehow back to the parent company. We hadn't worked out how, but ultimately there would be a dividend passed up. From where to where? ‑ Well from subcos right through to Spassked. Does that mean that you discussed in the latter part of 1987 that the ultimate return of such realised capital investments would be by way of dividend, up the structure? ‑ In order for the directors of Spassked to make the investment, they had to - we were very mindful of their fiduciary duties which would mean they would be expected to get a return on their investment. Yes? ‑ So therefore we were expecting substantial dividends to come up to Spassked in due course, whether by the liquidation or just a dividend and then return of capital." 204 Cottam complained more than once that he could not reasonably be expected to remember conversations ten to fifteen years ago. I do not blame him in the slightest for his inability to do so. But the fact remains that, in the light of the absence of contemporaneous records as a result, apparently, of Brierley's deprecation of paper work, Spassked is now obliged to rely on the recollections of Cottam (and Daniels) to persuade me as to the states of mind in 1987 of themselves and of others. Cottam's testimony did not assist Spassked's case in the present respect. I regard the passage set out above as evidence that Cottam's understanding was that the law would require that eventually Spassked receive some kind of return on its investment in GIH, in some unidentified form and by some unidentified mechanism. In my opinion, this does not amount to an expectation of deriving assessable (dividend) income which occasioned the borrowings from IEL, or the purpose for which Spassked was carrying on business, within subs 51(1) of the Act. 205 The present issue was first taken up with Daniels as follows: "You referred in various places [in] paragraphs 57 through to 72 [of Daniels' main affidavit] that you envisaged Spassked would derive dividend income but that would only occur, would it not, once Spassked had ceased to be a dividend trap? - Correct. It is also the case, is it not, that it would not occur whilst Spassked had tax losses available to it which could be transferred to other members of the group?- Of any material amount, yes. Of a material amount. So that as you envisaged the structure, Spassked would derive - commence to derive dividend income once it had ceased to be a dividend trap and once it had transferred out all of its carried forward losses?- Yes. Did you turn your mind in mid-1987 as to how Spassked would cease to be a dividend trap? - Yes. In mid-1987 how did you envisage that would occur? - Primarily I thought -I believed that the investments within the Spassked group would be on the whole profitable as they had been in the past history of IEL to such an extent that the trading surpluses would be sufficient within a fair period of time to enable the debt to be paid down and dividends to flow. I understand that the subsidiary companies of - you envisaged the subsidiary companies of the Spassked structure to derive profits and that you envisaged that Spassked would at some stage re-pay the debt to IEF but had you turned your mind as to how it was that the profits were going to be passed from subsidiaries of Spassked to Spassked to enable it to re-pay its debt to IEF? - Yes, I thought the most likely scenario would be that there would be an accumulation of funds at the Group Investment Holdings level and that debt would be paid down by a combination of either a loan of those funds or dividends and/or both at a point in time and of an amount sufficient to pay down the debt. But of those two alternatives it was unlikely indeed, was it not, Mr Daniels, that Spassked would receive the funds necessary to retire its debt by way of a dividend payment from GIH? - It's possible. Possible but unlikely? - Oh no, not really. Not based on the profitability indicators that the company had experienced in the mid 80 years. But it is true, is it not, that your perception of the structure was that Spassked would derive [sic - accrue] capitalised interest for a number of years and that the - the first tranche, for example, … the first amount of money that was put into Spassked was in - the second I should say - in January 1988 was in the vicinity of $950 million, was it not? - Yes. Well, capitalised interest on $950 million accruing over a number of years would have given rise to a considerable interest debt? - As it did. As it did. And indeed as it turned out a considerable - small amount of money was injected into Spassked by way of loans, indeed up to about $3.7 billion, is that so? - I think the total loan from IEF to Spassked was of that order, yes. So that as the proposal was initially conceived and indeed shortly after it was implemented it became apparent, did it not, that for Spassked to pay off its debt it would require very significant funds to do so? - And I expected that to come from the profits of the underlying investments. And a major objective of the proposal of the structure was to avoid paying dividends into a dividend trap? - Yes. Well, it wouldn't have happened, would it, Mr Daniels, that a considerable dividend - it was expected that a considerable dividend would be paid out of Group Investment Holdings into Spassked in circumstances in which Spassked was ... a dividend trap? - We've stated that. Yes. Well, in those circumstances, I put it to you, Spassked - it was never genuinely envisaged that Spassked would derive the funds necessary to pay off it's debt from a dividend receipt? - It - well if I could take you to my - the paragraph 40 [a reference to par 40 of Daniels' first affidavit]. And if you have a look, it [is] misdescribed on the first affidavit but if you look at that table (see [72] earlier). On the last column in that table it gives an indicator of the profitability of this group and you'll see these are returns which are after tax, after interest and I think by any standard they are extraordinarily good returns. Now if you take the assumption, which I did, that the Spassked group investments were a proxy for the IEL group investments, I could see no reason why one could not expect those returns to continue and hence my expectation was that this group would continue to be profitable, would continue to derive substantial surpluses on its investments and provide a significant flow of funds to Group Investment Holdings, some of which may have been the amounts obtained on the disposal of investments [the] majority of which would have been income and there would have been a sufficient sum based on those expectations to repay both principal and debt [sic - interest]. Let's proceed on for the moment, Mr Daniels, that your expectations about the quantum of funds available to GIH, exceeding the value of the debt that Spassked owed? - Could you - sorry, repeat that. Let's assume for the moment that your expectations are well founded? - Yes. That GIH would at some time in the future derive a sufficient pool of funds to enable to Spassked to pay off its debt to IEF? - Yes. It's the case, is it not, that in order for Spassked to pay off its debt, GIH would simply lend the funds to Spassked for that purpose? - Well it could have done that. Well it could have. The advantage of doing it that way wasn't it was that you would not then be paying dividends into a dividend trap? - It would have had the option of using those funds to lend to its parent, presumably interest free. It would have had that option? -Yes. But in [the] circumstances, Mr Daniels, where the structure is set up to avoid dividend traps, why would you GIH pay a huge sum of money into a dividend trap as a dividend? - But that - but it could do that and avoid the dividend trap problem. But it is the case, is it not, that until Spassked ceased to accrue capitalised interest? - Yes. It would be a dividend trap? - Yes. And in order for it to cease to be a dividend trap either IEF [must] stop charging interest or Spassked [must] pay back its debt? - Yes. So that whilst the debt existed and Spassked was incurring capitalised interest, GIH would not have streamed funds up to Spassked as a dividend? - I agree. If it were going to do so it would do it as a loan? - It is quite possible conceptually for it to have been paid by a dividend and I would expect that to have been paid very early in the fiscal year and that would have satisfied the requirements of the group. Well, it is also the case, is it not, Mr Daniels, that a substantial dividend would not have been paid whilst Spassked still had carry forward losses that were available to be transferred throughout the group? - That's true. So that your expectation of the company deriving dividend income was that it would derive income once it ceased to have losses available to transfer around the group? - Yes." (my emphasis) 206 In the passage set out above, Daniels is testifying as to his state of mind in the latter half of 1987 when the Spassked Structure was devised. I am not satisfied that his state of mind at that time was that of Spassked's other directors at that time. But perhaps more importantly, I am not satisfied that Daniels himself expected (even in the neutral factual sense discussed at [165]) that Spassked would cease to accrue interest to IEF, would cease to have tax losses, and would then commence to receive dividends from GIH, as a result of the payment of one large dividend by GIH to Spassked "early in the fiscal year". In this respect, I think he has engaged in a process of reconstruction of his 1987 thought processes, either in the witness box or in preparation for the hearing, or both. The answers "It's possible" and "It is quite possible conceptually ..." suggest a present day rationalisation rather than an account of something thought about in 1987. If Daniels thought about the matter at all in 1987, he would have thought about discharge of Spassked's indebtedness to IEF by the obvious means of an interest free loan from GIH rather than by means of the contrived payment of a huge dividend in the first few days of a fiscal year. Moreover, Daniels' own testimony leaves unexplained why or when Spassked would wish to start receiving dividends or feel compelled to require that it start receiving them. 207 Finally, I have discussed Daniels' expectation above as a neutral factual matter. As ever, this is insufficient to satisfy the first limb of subs 51(1). What is required is that the expectation be the occasion of, or reason for, the incurrence of the outgoing - the purpose of that incurrence. Daniels' testimony falls far short of meeting that test. 208 In cross-examination Daniels agreed that it was not an element of the Spassked Structure how or when it should be unwound. But he disagreed that the Spassked Structure was expected to last indefinitely, while adding less clearly: "I am not sure that I did consider that it would have an indefinite life."

"But its duration and length was something that could be left to be determined at another day?-Well, the decision was made to monitor the progress of the Spassked investment as there was a number of unknowns, one of which was the actual profitability of the group, another was the potential for legislation to change. It was not feasible to make a permanent or a long term plan for the structure. And therefore I take it that whilst you held an expectation that over time GIH would derive a sufficient pool of profits to enable Spassked to pay out its debt you had not turned your mind as to what length of time that might be?-I've always had in my mind that it would take some years but, no, there are just too many unknowns to put a time limit on it." 209 In cross-examination the following day, when asked what his expectation was as to the time frame required for GIH to accumulate a pool of funds that exceeded Spassked's debt to IEF, Daniels replied, "[w]ell, at the time it started I had a view based on my experience that the time frame would be a medium term, somewhere between say five and ten years." When Daniels' attention was drawn to what the cross-examiner suggested to him was an inconsistency between this testimony and that given the previous day (that "there [were] just too many unknowns to place a time limit on" the period needed for GIH to derive the required funds), the following exchange occurred: "…I will repeat what the transcript importantly is asking you: 'And therefore I take it that whilst you held an expectation that over time GIH would derive a sufficient pool of profits to enable Spassked to pay out its debt you had not turned your mind as to what length of time that might be.' Your answer was: 'I had always in mind that it would take some years but no, there are just too many unknowns to put a time limit on it.' Now, it is correct to say, is it not, that at the time the proposal commenced you were of the view that there were too many unknowns to determine when? ‑ A precise date. As possibly distinct from a range of dates." 210 In order for the Spassked Structure to be unwound it was necessary for Spassked's debt to IEF to be paid out, an event that could occur only when a sufficient pool of funds had been accumulated in GIH. Therefore, the accumulation of sufficient funds in GIH was a necessary precursor to, and bore upon the issue of, the unwinding of the Spassked Structure. According to both versions of Daniels' testimony set out above, Daniels was saying that back in 1987 he thought about the likely lifespan of the Spassked Structure. I do not accept his later version as an explanation of the earlier one. According to the earlier version, he did not have any view as to the duration of the Spassked Structure because, although he thought about the matter, it was impossible to form a view. According to the later version, however, he thought about the matter and settled upon a likely lifespan of five to ten years. 211 Daniels acknowledged that in 1987, when the Spassked Structure was devised, there were no calculations, business plans or "formal projections" as to the likely future course of the generation of a fund of profits in the Subcos, and therefore as to the feasibility of eliminating Spassked's debt to IEF and its accompanying interest liability, or as to the likely timing of such a development. Clearly, an expectation or purpose may exist in the absence of such precise modes of planning, but their absence is of some relevance to that existence, even in a corporate group run on informal lines, like the IEL Group. Moreover, in the passage set out above at [208], Daniels said that it was not feasible to make even "a long term plan for the structure". 212 I found Daniels' testimony on the present issue unconvincing. My conclusion is that either he did not think about the likely duration of the Spassked Structure at all or that he gave it fleeting consideration and had no hesitation in thinking that it was something with which he need not concern himself as his hope was that the Spassked Structure would continue to be used so long as it was useful and no change of circumstances or legal considerations required it to be abandoned. I find that he did not foresee any particular occasion for it to be unwound. 213 Daniels was clear that when the Spassked Structure was devised and implemented, Spassked had no requirement for dividends. His expectation that it would not receive dividends for as long as it remained a dividend trap or had carry forward losses deserves emphasis. The following exchange occurred: "Apart from IEL needing income, is there any other reason why Spassked needed income? - Eventually I suppose it's fair to say I always understood with this proposal that at the end of the day it would be necessary for a dividend to be paid to Spassked, otherwise it may be that the whole deductions to Spassked are brought into question by means of an undue delay between the receipt of a dividend and the underlying interest deductions. But it is true to say isn't it, that while Spassked was a dividend trap and whilst it had losses available to it to transfer around the group, it had no requirement for income? - That's true at that point, yes. And that for it to have a requirement of income required two things to occur. First that it should cease to be a dividend trap and secondly for it to have ceased to have any losses available to it to transfer to the group? - Yes." (my emphasis) I do not treat this passage as showing that Daniels expected that GIH would pay a dividend to Spassked. Rather, it amounts only to evidence that he understood that there was a tax law issue which might unfortunately need to be resolved somehow at some undefined future time, if it should prove possible and necessary, by payment of a dividend by GIH to Spassked. This is far removed from an expectation in the positive sense discussed in Ronpibon (see [164] - [166] above). 214 The following exchange occurred in Daniels' cross examination: "I want to come back, Mr Daniels, to the expectations of ultimately deriving sufficient profits through the Spassked group to achieve a fund of profits in GIH which would equal or exceed the amount of the debt owed by Spassked to IEF. At the time the proposal in paragraph 54 [a reference to par 54 of Daniels' first affidavit, set out at [80] earlier] was conceived, your evidence, as I understand it, is that you'd formed an expectation that over a period of time such a fund of profits would be obtained and located in GIH? ‑ Yes. Had you made any calculations or any business plans to work out whether that was a realistic expectation or not? - You mean back in 1987? Yes? - I mentioned that yesterday, no, there were no formal projections. Is that because you didn't see the ability of GIH to obtain such a fund of profits as being an integral part of the proposal? - Could you repeat that? Is the reason why you didn't make any calculations because you didn't see the ultimate ability of GIH to obtain a fund of profits equalling or in excess of Spassked's debt as being critical to the proposal that you had decided upon and which is referred to in paragraph 54? - It's such a long question. I'll have to answer it in this sense that I - my expectation was that it was critical that a fund of profits be established at some point in time in GIH. A fund of profits that was equal to or in excess of the quantum of Spassked's debt? ‑ I expected it had funds within GIH which is a composite of largely earnings but possibly funds derived from disposals and other business activities and that sum would be sufficient to enable the debt of Spassked to be repaid and with a - either a subsequent dividend or a dividend at that point in time. But you made no computations about whether those expectations were realistic or not? - My recollection is that I expected, based on the earnings record of the group, that there would be a significant surplus emanating from this group. It was - to me it was not feasible to try to put something on paper because I think I outlined the reasons yesterday. It was an expectation in the medium term that it would be monitored, monitored from time to time, and we would respond to conditions as they were there and legislation as it was at particular times. It was - did not seem appropriate to try and make unreal - basically useless forecasts. It is the position, though, isn't it that effectively you couldn't say with any degree of rationality whether there would be a point of time when the all of the profits in GIH would be equal to or in excess of the debt owed by Spassked? ‑ I disagree with that. It is correct to say, isn't it, you made no computations about the time that would be required for that fund of profits to be obtained? - I had in my mind there was a range of times where I would - I expected that the dividend would flow from GIH to Spassked. It was clearly the position, wasn't it, that when you entered into or when the Spassked proposal was commenced that it was possible that a fund of profits would never been obtained by GIH to the extent that it equalled to or exceeded Spassked's debt? ‑ Are you asking me whether that was my expectation? I'm asking you whether, yes, you believed that that was a possibility? - That it would never? No, I did not expect that to be the case. And you didn't recognise it as a possibility? - As a possibility that the - if it was recognised it would've been given a weighting that was in the remote scale."

The cross-examiner took Daniels to the table in his affidavit which appears at [72] earlier, and, in particular, to the figures for percentage "return[s] on average [shareholders' funds]"in that table, and asked whether any computations had been made as to whether a continued return on shareholders' funds at those rates would give rise to a pool of funds in GIH sufficient to pay out Spassked's debt to IEF. There followed the passage below:

"Well, I know from my experience that if you are earning well in excess of the rate of interest paid by Spassked, that those profits which will compound will rapidly exceed the interest liability of Spassked and there would be a surplus again compounding which would provide a significant source of funds to enable the principal component to be repaid as well. It's just a mathematical fact if you earn at a rate in excess of which you earn [sic - accrue interest] therefore you're accumulating funds to enable your principal to be repaid. There's no rocket science about it, it's a very simple proposition. But I'm just trying to - that is a simple proposition, Mr Daniels, and one can quickly do a computation that works out the interest rate or expected interest rate that Spassked would be incurring and compounding by reason of the capitalisation? ‑ Yes. And comparing that interest rate to the interest rates in the table? - Yes. And working out some time frame over which - ? ‑ Yes, you can do that. I can do it my head for you now if you wish. Well, can you just state for the moment as to what your expected interest rate on Spassked would have been? ‑ I can't recall. You can't recall? ‑ No. But you would have to know firstly that figure?-If one was - it was one of the reasons why we didn't go through this computation of this exercise that you're assuming that should have been made because there's so many variables in working out that - I did not think it necessary because my expectation was irrespective of the interest rate, the company would earn a return which would be sufficiently above that rate to enable a - an amount of funds to be aggregated in that group to eventually - well in the medium term whatever that figure was, to allow it to reduce to nil the debt owing by Spassked. But, Mr Daniels, you could do a computation could you not by working out the expected amount of funds to be injected into Spassked in the initial period and working out the expected interest rate that Spassked would incur. Working out the costs of Spassked on the basis that the interest would be capitalised and compounded and then comparing the expected financial position of Spassked with the returns on average shareholders' funds that you have referred to in the table. And are you saying that that sort of exercise was never done?-No, not in a formal sense, no. Well, it was clear was it not, Mr Daniels, that within six months of the structure commencing, GIH was never going to be in a position of having a pool of funds that equalled or exceeded the amount of Spassked's debt?-But that happened. I mean that's the fact. So you want me - you are asking me to say that six months after it commenced, that I had no expectation - you were stronger than that. You were asking me to say that I had no expectation which I just cannot agree with that." 215 Senior counsel for the Commissioner then took Daniels to the following figures relevant to the end of the 1988, 1989 and 1990 years of income, which were the years in which Spassked's ten borrowings from IEF took place. (I have included below, merely for convenience and completeness, those as at the end of the 1991, 1992, 1993 and 1994 years of income as well.) 216 As at the end of 30 June 1988 Spassked was indebted to IEF for $2,043,184,428.82 including capitalised interest of $113,184,428.82 for the 12 months to 30 June 1988. As appears in the table in [137] earlier there would have been a consolidated fund of profit available to be paid to Spassked in that year of $98,625,459. In addition, as appears in that table, based on the statutory accounts, there were net consolidated unrealised gains of $30,919,011 which would have been available for distribution to Spassked if assets were disposed of in that year. (Daniels agreed that his expectation was that while Spassked remained a dividend trap, GIH would not pay anything more than a nominal amount to it as a dividend. No dividend was paid to it in the year ended 30 June 1988.) 217 Comparable figures for the succeeding years are as follows: 218 As at the end of 30 June 1989 Spassked's indebtedness to IEF was $3,469,206,194.67 including capitalised interest for the year of $293,220,636.85. The consolidated fund of profit available for the purpose mentioned was $304,868,025. (Daniels' expectation noted at [216] above is relevant. Again, GIH paid no dividend to Spassked for this year.) 219 As at the end of 30 June 1990 Spassked's indebtedness to IEF was $4,397,955,113.90 including capitalised interest for the year of $508,793,805.23 (this figure was later adjusted to $658,487,229.23). The consolidated profit available for the purpose mentioned was $901,363,305. (Daniels' expectation noted at [216] above is again relevant. On 30 June 1990, GIH paid to Spassked an unfranked dividend of $29,308,093.) 220 As at the end of 30 June 1991 Spassked was indebted to IEF for $5,322,395,063.90 including capitalised interest for the year of $774,746,526. The consolidated profit available for the purpose mentioned was $1,338,749,042. (Daniels' expectation noted at [216] above is again relevant. GIH paid no dividend to Spassked for the year ended 30 June 1991. In the latter half of this financial year, the dispute with the ATO also became a consideration relevant to any payment of dividends.) 221 As at the end of 30 June 1992 Spassked was indebted to IEF for $4,099,653,386.82 including capitalised interest for the year of $888,165,526. The consolidated profit available for the purpose mentioned was $1,729,279,541. In addition, based on the statutory accounts, there were net consolidated unrealised gains of $542,983,875 available for distribution to Spassked if assets were disposed of in that year. (Daniels' expectation noted at [216] above is again relevant. The dispute with the ATO is also relevant to any payment of dividends. On 8 October 1991, GIH paid a dividend of $14,654,046 to Spassked.) 222 As at the end of 30 June 1993, as a result of transactions on 1 January 1993 and 31 May 1993, Spassked's indebtedness to IEF had been decreased and it was indebted to GIH. In the 1993 year, GIH lent $728,275,275.67 to Spassked (interest free) which Spassked paid to IEF in reduction of its indebtedness to that company. Spassked was indebted to IEF for $3,837,004,852.15 including capitalised interest for the year of $465,626,741. The consolidated profit available for the purpose mentioned was $2,108,727,039. In addition, based on the statutory accounts, there were net consolidated unrealised gains of $1,076,174,438 available for distribution to Spassked if assets were disposed of in that year. But Spassked was now also indebted to GIH for $2,795,220,339.75. Spassked's indebtedness to IEF and GIH together therefore totalled $6,632,225,191.90. (Daniels' expectation noted at [216] is again relevant to the question of payment of dividends as is the dispute with the ATO. In fact, GIH paid no dividend to Spassked in respect of this year.) 223 As at the end of 30 June 1994 the position was as follows. On 29 June 1994 Spassked borrowed $6,939,026.66 from GIH and paid it to IEF. In the 1994 year, GIH lent $3,596,412,841.19 to Spassked (interest free) which Spassked paid to IEF in reduction of its indebtedness to that company. As at the end of 30 June 1994 Spassked was indebted to IEF for $319,876,033.96 including capitalised interest for the year of $79,284,023. The consolidated profit available for the purpose mentioned was $3,045,199,551. In addition, based on the statutory accounts, there were net consolidated unrealised gains of $123,264,041 available for distribution to Spassked if assets were disposed of in that year. But Spassked was now also indebted to GIH for $6,391,633,180.94. Spassked also owed $1,249.30 to IEL. It repaid the debt to IEF on 1 July 1994. On that date it borrowed $259,876,034 from IEL and $60,000,000 from GIH and paid the total of $319,876,034 to IEF in discharge of the balance of its indebtedness to IEF. (Daniels' expectation noted at [216] above is again relevant, as is the dispute with the ATO, to the question of payment of dividends. In fact GIH paid no dividend to Spassked for this year.) 224 The consolidated fund of profit in GIH available at 30 June 2000 had risen to $3,126,924,146 and, in addition, based on the statutory accounts, there were net consolidated unrealised gains of $205,740,768 available for distribution to Spassked if assets were disposed of in that year (see table at [137]), giving the highest ever aggregate figure of $3,332,664,914, yet the amount required to pay out Spassked's debts then was in the vicinity of $6.7 billion. 225 The funds available to be paid to Spassked never did attain a level sufficient to discharge the indebtedness of Spassked to IEF or to IEF's "replacement" creditor, GIH itself. Right from the beginning, GIH's consolidated fund of profit fell far below the level that would be necessary for the purpose. Of course, the fact that an expectation was not fulfilled does not signify that it did not exist. Many expectations are not fulfilled. The important point, however, is that Daniels could not recall ever, in June 1988, June 1989 or June 1990, considering whether, in the light of the disparity between the amount of Spassked's indebtedness to IEF and the amount of GIH's consolidated funds available to be paid to Spassked, what he said was his earlier expectation (that GIH's consolidated profits would provide sufficient funds to enable Spassked to discharge its liability to IEF, and, as a result, to cease to be a dividend trap) was realistic. Daniels also could not recall ever collating the figures for the average returns on shareholders' funds in GIH for the years 1988, 1989, 1990 and 1991. He did, however, recall having some doubts at the time of the takeover by the Adsteam Group (in November 1989), "whether the new management would be able to maintain the rate of profitability that the prior management had been able to extract". He said, however, that he thought this would "merely extend the term rather than mean that there would not be [a] sufficient fund of profits". This was a different matter: a comparison of managements. 226 The fact that throughout the 1988, 1989, 1990 and 1991 years of income, Daniels did not express alarm or consternation over the disparity referred to strongly suggests that using the consolidated fund of profit in GIH, whether or not supplemented by net consolidated unrealised gains, to pay out Spassked's indebtedness to IEF was not part of Daniels' thinking at the time. It shows that that way of proceeding did not form part of any plan he had in mind for Spassked. 227 If there had been discussion of any requirement to pay dividends to Spassked and, to that end, first to discharge Spassked's debt to IEF and to transfer out any remaining losses, Daniels would be likely to remember it. Any suggestion of a need to follow that course would have sounded an unwelcome and jarring note. 228 I turn now to consider Cottam's testimony on the present issue. In cross-examination Cottam described what was, as far as he was concerned, "the principal purpose" of the Spassked Restructuring as follows: "To have a group of new subsidiaries with no corporate history available, new subsidiaries, no corporate history available for new investment opportunities, funded appropriately for the proposed investment." He then assented to the cross-examiner's attempted paraphrase: "So far as you were concerned the primary utility of this was one of what you have referred to as the administrative convenience of being able to identify a company that would be appropriate to make an investment? - Yes." Cottam later conceded that, if it was subsequently decided to use a Subco to make an acquisition, the Subco would not in fact have ready cash available and would need to obtain it by, for example, calling up the whole or part of any amount it had deposited with IEF, which, in turn, might need to obtain the funds from a source external to the Group. The cross-examiner's purpose was to show that in substance the position was no different in this respect from that which would have existed if a shelf company had been used. 229 Cottam responded by suggesting that from an outsider's perspective, a Subco with a paid up share capital of, say, $150,000,000 would be more impressive as a bidder than a shelf company with a paid up capital of say $2.00. He agreed, however, that he had had no experience of dealing with takeover bidders which might support his idea that outsiders would prefer to deal with a capitalised subsidiary rather than a shelf company. He said he had come by the idea through discussions "in the corridors" with colleagues at IEL, whose identity he could not remember. 230 I found Cottam's testimony in this respect unpersuasive. Moreover, after the Spassked Structure was first used in December 1987/January 1988, shelf companies with a paid up capital of $2.00 were in fact used as takeover vehicles. Such companies, funded by debt rather than equity, were used to acquire Woolworths and Kern Corporation, for example. Cottam offered the explanation that the shelf companies used in those cases had already been used to take preliminary steps in connection with those acquisitions prior to December 1987/January 1988, so that their use after that time was, to use his description, a "fait accompli". Even if this explanation is to be accepted, in substance it suggests that the use of such shelf companies was hardly a pre-Spassked disadvantage to the Group. I am simply not at all convinced that the use of IEL shelf companies to effect takeovers was perceived to be such a disadvantage under which the Group laboured, or that the use of capitalised IEL subsidiaries was perceived to offer the Group such an advantage, that the Spassked Restructuring is to be explained by reference to such considerations. 231 In the course of the cross-examination of Cottam, the question of the method by which Spassked's debt to IEF would be discharged was explored. Like Daniels, Cottam suggested that the funds necessary to discharge the debt would not be paid by GIH to Spassked in a piecemeal manner.Instead, he said the Subcos would pass funds up to GIH, either by way of dividend or return of capital, and the funds gathered in GIH would then be declared by way of dividend up to Spassked. The following exchange occurred: "What you are saying, is this right, that as each of [the] subcos within the Spassked structure would realise its investment and be in a position to return capital back up to GIH and also dividend[s] perhaps retained or perhaps just for the current year. The position would be that GIH would not declare the dividend into Spassked until all of the investments had been realised and all of the capital had been marshalled so that the entire capital could be returned to Spassked and it could retire IEF's debt - That is the perfect situation, yes." 232 The declaration of a dividend by GIH to Spassked raised the question of whether the payment of that dividend would necessarily be a payment into a dividend trap; an event that both Daniels and Cottam had said would be avoided. Cottam suggested the Group could avoid trapping in Spassked any dividend paid to it by GIH if that dividend were paid so as to enable Spassked to discharge its debt to IEF (capital borrowed and the capitalised interest of previous years) early in the financial year. The idea is that by discharging the debt early in the year, Spassked would be able to forestall the accrual of any interest for that year and thus ensure that dividends were able to flow freely through it to IEL. The following exchange occurred during the course of cross-examination: "So what you're saying is that the dividend from GIH to Spassked early in the financial year could be used to finish off discharging the debt owed by Spassked to IEF? - That's correct, yes. And prevent interest expense running in that year? - That's correct. And as long as that were done then Spassked would not trap the dividend? - Yes. And there would be no loss of rebate? - Yes. That's just one way it could be done. That's just one way of doing it? - Yes." Cottam said he had no recollection of discussions in the latter half of 1987 about ways of unwinding the Spassked Structure, but said he recalled discussions about the necessity that a dividend ultimately be paid to Spassked if its directors were to "discharge their fiduciary duties to the company". I do not accept this evidence of generalised discussion with unidentified persons about this issue as evidence that an expectation of receiving dividends from GIH was the occasion of Spassked's borrowing from IEF. 233 Cottam said the two dividends were paid by GIH to Spassked because dividends were being paid by GIH to IEL at the same time. That is to say, someone suggested at that time that since a dividend was in the course of being paid to IEL, one should also be paid to Spassked. If so, this hardly suggests that payment of dividends to Spassked was part of the original plan back in late 1987, or from then down to 1990. Cottam's evidence in the present respect was generally unsatisfactory. He could not recall any of the directors of Spassked (or of GIH - the same persons) stating that Spassked should be seen to be receiving a return on its investment in GIH. The following relevant exchanges occurred in Cottam's cross-examination: "Do you recall in any discussion of its being appropriate to declare a dividend to Spassked at the same time as declaring one to IEL of why that was so? - Just because cosmetically it looked, you know, well, not looked, it was IEL got a dividend so Spassked should get something for its investment, small as it may be. But when you say cosmetically, for appearances to whom? - Well, for the directors of Spassked so they could say they got something back on their investment. They were pretty much the same people as the directors of GIH weren't they, in those two years? [the years ended 30 June 1990 and 30 June 1992] - I would have thought so. There would at least have been a majority overlap in the boards, wouldn't there? - I think that is the case but I can't say for certain. Since there were common directors on both sides, why did Spassked need to be able to say that they got something back for their investment, to whom? - Because they hadn't - for the directors they hadn't received anything from their investment if a dividend hadn't been paid." (my emphasis)

234 GIH in fact paid the following dividends to IEL and Spassked: Year ended Date franked dividend paid to IEL Amount of franked dividend paid Date unfranked dividend paid to Spassked Amount of unfranked dividend to Spassked to IEL 30.6.88 29.6.88 $4,800,000 Nil 30.6.89 1.7.88 1,777,725 Nil 30.6.89 12,987,325 30.6.90 14.6.90 3,558,000 30.6.90 29,308,093 14.6.90 10,023,700 30.6.91 Nil Nil 30.6.92 1.10.91 49,999 8.10.91 14,654,046 30.6.93 1.7.92 182,079 Nil 30.6.94 Nil Nil TOTALS $33,378,828 $43,962,139

(Daniels' affidavit states that the dividend of $182,079 paid to IEL is shown in GIH's statutory accounts as having been paid on 30 June 1990.) 235 These figures make it difficult to accept that the two dividends were paid to Spassked because of a concern to give an appearance of equitable treatment of GIH's two shareholders. The amounts of their investments in GIH were so disparate that equitable treatment would require that Spassked receive much more than the two amounts totalling $43,962,139 which it was paid. 236 I do not accept that it was part of the plan, purpose or expectation (in the sense explained) of the Spassked Structure that GIH would pay dividends to Spassked. I am prepared to accept that whatever the precise reasons for payment of the two dividends were, they arose spontaneously at the time and may, indeed, have been an attempt to create an appearance.

Summary 237 Clearly there may be a subjective expectation or purpose which is not well founded and is ill-considered and even irrational. But in the present case, I am simply not persuaded that there was, in the latter half of 1987, or at any time from then down to 28 June 1990, a motivation, subjective purpose or subjective expectation (in the sense explained earlier) that GIH would ever pay dividends to Spassked. I find that neither the directors of Spassked nor the IEL Group's Administration Team discussed any means by which Spassked might ever receive dividends from GIH, because its doing so was not a part of their plan and was in fact inimical to it. There was no good reason why they should be thinking about destroying or reducing the utility of the Spassked Structure. I find that their hope was that it might remain in place indefinitely. 238 The most that I would be prepared to find is that Daniels, one of Spassked's four directors and a member of the Group's Administration Team, and Cottam, also one of the members of that Administration Team, thought that it may prove to be necessary one day, because of legal constraints relating to either the fiduciary duty of Spassked's directors or the tax deductibility of the interest paid by Spassked, for some means to be found for Spassked to receive dividends from GIH, and if it did, this may be able to be achieved by resorting to the funds of GIH to discharge Spassked's indebtedness to IEF. This falls far short of signifying that the occasion of the incurring of the interest expenses was an expectation of receipt of dividends or that Spassked incurred the interest expenses in carrying on a business for the purpose of receiving dividends from GIH. 239 I accept that the question of the long term future of the Spassked Structure may have fleetingly crossed the minds of Daniels and Cottam. But that was as far as it went. I find that what was important to them was to achieve the immediate objectives of making Spassked the dedicated dividend trap and loss centre of the Group: attention could be given to any unwelcome necessity which might exist for it to receive dividends from GIH in the future if and when the occasion to think about that unpleasant matter arose. 240 I do not accept that Daniels or Cottam expected (now in the neutral factual sense) that Spassked would receive, or was likely to receive, dividends from GIH. In so far as their testimony is to the contrary, I think they have engaged in a process of reconstruction of their 1987 thought processes. (It should go without saying that this does not suggest fabrication.) Having regard to the disparity between the large and rapidly increasing indebtedness of Spassked to IEF on and from 30 December 1987 down to 28 June 1990, and the level of GIH's funds available to be paid to Spassked at any time during that period, and the lack of alarm or protest over that disparity at the time, I conclude that they saw nothing untoward in that growing disparity. Their acquiescence points against a subjective expectation or purpose that GIH's funds were to be used to discharge Spassked's debt to IEF. 241 I am not persuaded that Daniels or Cottam assessed or thought of the Spassked Structure as having a likely lifespan of five to ten years. I find that either they did not direct their minds to its lifespan at all, or that if they did, it was regarded as of no significance whatever and as something which may or may not call for attention at some unidentified future time. I think they arrived at the "five to ten years" estimate in the witness box or at least while reflecting upon the case in relatively recent times, not back in 1987 when the Spassked Structure was devised. 242 The ATO's claims and resulting disputation prove to be of no significance. I accept Daniels' testimony that the potential tax liability might well have inhibited payment of dividends if such a payment had been otherwise contemplated. But it was not contemplated: GIH was already committed to a course of not paying dividends to Spassked. It is not to the point to say that if Spassked had ceased to be a dividend trap and if it had ceased to have tax losses, nonetheless dividends would not have been paid to it for a new supervening reason: the possible tax liability. The character of the interest expense must be determined as at the time of its incurrence, in this case at the times of the borrowings of the money on which it accrued. It is at those times that expectations and purposes are to be identified. The position might be different if the ATO had asserted the tax liability before the first occasion of decision as to whether GIH was to pay dividends to Spassked, or if, somehow, the Commissioner's only reason for regarding the interest expenses as non-deductible was the non-payment of dividends to Spassked after the outbreak of hostilities between the Group and the ATO. 243 I have dealt at length above with the states of mind of Daniels and Cottam. It should be emphasized, however, as I said earlier, that on the basis of the objective facts alone, that is, leaving their states of mind out of account, I would have no difficulty in concluding that the interest expense is not shown to be within subs 51(1). My purpose in addressing the states of mind of Daniels and Cottam is to allow for the possibility that the expense is within the subsection after all, notwithstanding appearances. The relevance of Cottam's state of mind is doubtful in any event because he was not a director of Spassked at the relevant times, and I have not been prepared to attribute Daniels' state of mind to his co-directors. 244 For the above reasons, I do not think that the required expectation (in the positive sense explained at [164]-[166]) or purpose is established, even having regard to Daniels' and Cottam's testimony as to their subjective expectations and purposes. 245 Spassked's interest expense of $888,165,526 paid to IEF in respect of the year of income ended 30 June 1992 was not a loss or outgoing incurred in gaining or producing assessable (dividend) income from GIH, or necessarily incurred in carrying on a business for the purpose of gaining or producing such income.

Part IVA issues 246 Because of the conclusion just expressed, I am not required to address the Part IVA issues.

conclusion 247 For the above reasons, the sum of $888,165,526 was not an allowable deduction and the purported losses founded upon its deductibility transferred by Spassked to SPL and IEL were not available to be so transferred. 248 In fact, in the year of income ended 30 June 1992 GIH paid Spassked a dividend of $14,654,046. The parties did not make submissions in relation to the apportionment of the outgoing of $888,165,526, but treated the issue of its deductibility as an "all or nothing" affair. If the issue of apportionment is to be addressed, the parties may do so as part of their written submissions referred to in the next paragraph. 249 I will direct the parties to bring in agreed short minutes of orders to be made disposing of all three proceedings, consistently with the above reasons, and if agreement is not reached, the short minutes of orders for which they will respectively contend, accompanied by written submissions in support. I certify that the preceding two hundred and forty-nine (249) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Lindgren.

Counsel for the Applicant D H Bloom QC, A H Slater QC, in each proceeding: P M Fraser, J Hmelnitsky

Solicitor for the Applicant Blake Dawson Waldron in each proceeding:

Counsel for the Respondent G J Davies QC, D J Fagan SC, in each proceeding: M A Painter, S H Steward

Solicitor for the Respondent Australian Government Solicitor in each proceeding:

Dates of Hearing: 15, 16, 17, 18, 22, 23, 24, 29, 30 April, 8 May 2002

Subsidiary Transfer or Date of allotment Number of shares Par value per share Total Consideration Allotment or transfer Harbour Securities Pty Limited Allotment 30-Dec-87 25,000,000 1.00 25,000,000 Datwillow Pty Limited Allotment 18-Jan-88 50,000,000 1.00 $50,000,000 Datside Pty Limited Allotment 18-Jan-88 100,000,000 1.00 $100,000,000 Harbour Securities Pty Limited Allotment 18-Jan-88 225,000,000 1.00 $225,000,000 Kachuga Pty Limited Allotment 18-Jan-88 100,000,000 1.00 $100,000,000 Industrial Equity Acquisition (No. 31) Pty Limited Allotment 18-Jan-88 50,000,000 1.00 $50,000,000 Industrial Equity Acquisition (No. 32) Pty Limited Allotment 18-Jan-88 75,000,000 1.00 $75,000,000 Stringdale Pty Limited Allotment 18-Jan-88 25,000,000 1.00 $25,000,000 Stringcrest Pty Limited Allotment 18-Jan-88 25,000,000 1.00 $25,000,000 Stringbooth Pty Limited Allotment 18-Jan-88 75,000,000 1.00 $75,000,000 Industrial Equity Acquisition No. 21 Pty Limited Allotment 18-Jan-88 25,000,000 1.00 $25,000,000 Stringbrook Pty Limited Allotment 18-Jan-88 50,000,000 1.00 $50,000,000 Industrial Equity Acquisition (No. 37) Pty Limited Allotment 18-Jan-88 150,000,000 1.00 $150,000,000 Hargreave Securities Pty Limited Allotment 31-Mar-88 375,000,000 1.00 $375,000,000 National Self Service Pty Limited Allotment 1-Apr-88 100,000,000 2.00 $200,000,000 National Self Service Pty Limited Transfer 1-Apr-88 100,000 1.00 $341,758 National Self Service Stores Pty Limited Allotment 1-May-88 39,910,000 2.00 $79,820,000 Bureya Pty Limited Transfer 9-Nov-88 2 1.00 $2 National Supermarkets Pty Limited Transfer 22-Nov-88 5000 2.00 $9,826 Valeten Pty Limited Transfer 8-Feb-89 2 1.00 $2 Winter Management Limited Transfer 31-Mar-89 10,100,000 1.00 $7,351,681 Stringnil Pty Limited Allotment 19-Apr-89 100,000,000 1.00 $100,000,000 Industrial Equity Acquisition (No. 15) Pty Limited Transfer 1-May-89 2 1.00 $2 Ilimsk Pty Limited Transfer 1-May-89 2 1.00 $2 Argyle Securities Pty Limited Allotment 31-May-89 1,200,000 1.00 $1,200,000 Bendor Pty Limited Allotment 31-May-89 2,650,000 2.00 $5,300,000 Bourke Motels Pty Limited Allotment 31-May-89 400,000,000 1.00 $400,000,000 Hops Tasmania Pty Limited Allotment 31-May-89 30,000,000 1.00 $30,000,000 Country Producers Selling (1972) Limited Allotment 31-May-89 11,500,000 1.00 $11,500,000 Crooks National (Holdings) Pty Limited Allotment 31-May-89 23,500,000 1.00 $23,500,000 Fund Investment Pty Limited Allotment 31-May-89 13,500,000 1.00 $13,500,000 Guerdon Pty Limited Allotment 31-May-89 12,300,000 1.00 $12,300,000 IEL (Tasmania) Pty Limited Allotment 31-May-89 1,000,000 2.00 $2,000,000 IPE Holdings Pty Limited Allotment 31-May-89 3,000,000 2.00 $6,000,000 K Stroud Pty Limited Allotment 31-May-89 90,000 2.00 $180,000 Manhelm Pty Limited Allotment 31-May-89 128,500,000 1.00 $128,500,000 National Wholesalers Pty Limited Allotment 31-May-89 5,742 2.00 $41,003,622 Olenek Pty Ltd Allotment 31-May-89 205,000,000 1.00 $205,000,000 IEL No. 1 Pty Limited Allotment 31-May-89 3,350,000 1.00 $3,350,000 Parramatta Indoor Bowling Centre Pty Limited Allotment 31-May-89 5,750,000 2.00 $11,500,000 Portfolio Services (Nominees) Pty Limited Allotment 31-May-89 49,400,000 1.00 $49,400,000 Portfolio Services (Nominees) Pty Limited Allotment 31-May-89 49,400,000 1.00 $49,400,000 Resources Holdings Pty Limited Allotment 31-May-89 63,000,000 1.00 $63,000,000 Stringtell Pty Limited Allotment 31-May-89 1,850,000 1.00 $1,850,000 Sordale Pty Limited Allotment 31-May-89 2,705 2.00 $3,497,565 Spurious Pty Limited Allotment 31-May-89 40,000,000 1.00 $40,000,000 Taleve Pty Limited Allotment 31-May-89 8,000,000 1.00 $8,000,000 Tehike Pty Limited Allotment 31-May-89 83,400,000 1.00 $83,400,000 Tehele Pty Limited Allotment 31-May-89 2,200,000 1.00 $2,200,000 Tehonu Pty Limited Allotment 31-May-89 16,200,000 1.00 $16,200,000 Tejasa Pty Limited Allotment 31-May-89 35,000,000 1.00 $35,000,000 Vajuna Pty Limited Allotment 31-May-89 2 1.00 $15,000,000 W B Breads Pty Limited Allotment 31-May-89 10,000 1.00 $10,000 Romola Pty Limited Allotment 31-May-89 15,000,000 1.00 $15,000,000 Maya Licensed Grocery Pty Limited Allotment 31-May-89 27,500,000 2.00 $55,000,000 Norman & Sons Pty Limited Allotment 31-May-89 1,000,000 2.00 $2,000,000 Tejigi Pty Limited Transfer 1-Jul-89 2 1.00 $2 Tehihi Pty Limited Transfer 1-Jul-89 2 1.00 $2 Tehoma Pty Limited Transfer 1-Jul-89 2 1.00 $2 Tehiyo Pty Limited Transfer 24-Aug-89 2 1.00 $2 Datwillow Pty Limited Allotment 28-Sep-89 59,999,998 1.00 $59,999,998 GET Auctions Pty Limited Transfer 3-Nov-89 2 1.00 $2 Industrial Equity Acquisition (No. 15) Pty Limited Allotment 15-Mar-90 99,999,998 1.00 $99,999,998 Industrial Equity Acquisition No. 21 Pty Limited Allotment 19-Mar-90 145,000,000 1.00 $145,000,000 Industrial Equity Acquisition (No. 15) Pty Limited Allotment 28-Jun-90 155,000,000 1.00 $155,000,000