Tech Mahindra Limited v Commissioner of Taxation

1. INTRODUCTION 1 On 7 October 2015, I delivered judgment in Tech Mahindra Limited v Commissioner of Taxation [2015] FCA 1082 (Tech Mahindra (No 1)). In that decision, I dismissed in part the applicant's appeal pursuant to s 14ZZ(1)(b) of the Taxation Administration Act 1953 (Cth) (TAA) against the Commissioner's decision (the Objection Decision). In that decision the Commissioner had dismissed in part the applicant's objection to the notice of assessment of income tax payable for the financial year ended 30 June 2008 (the relevant year). 2 The issue on the appeal was whether, as the applicant contended, it was not liable to tax in Australia in respect of income earned from services performed for Australian customers in the relevant year by employees located in India (the Indian Services), as opposed to those performed by employees located in Australia. In Tech Mahindra (No 1), I held that part of the income generated by the Indian Services for the relevant year is liable to taxation under the Income Tax Assessment Act 1997 (Cth) on the ground that payments made in Australia for certain categories of services undertaken in India constitute royalties under the Agreement between the Government of Australia and the Government of the Republic of India for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income (the Indian Agreement) and are deemed to be income derived from Australian sources. Specifically, at [155] I held that: …I consider that those payments which fall within categories 1, 2, 5, 6, 7 and 8 comprise royalties for the purposes of Article 12 of the Indian Agreement as enacted by the [International Tax Agreements Act 1953 (Cth)]. As such, those payments are deemed to have an Australian source by virtue of Article 23 and are therefore taxable as Australian source income by reason of s 6-5(3)(a) of the ITAA 1997. Certain payments within category 9 may also be taxable on the same basis. 3 Final orders were not then made for the reasons (also at [155]) that: …[T]he parties are agreed that I should not make findings as to the precise proportions of the total income from the relevant year which satisfies the definition of royalties in Article 12(3)(g) but rather afford the parties the opportunity first to seek to agree those proportions based upon my factual findings as to which of the 9 categories are correctly described as giving rise to royalties. That course is reflected in the orders providing only at this stage that the matter is set down for further directions. 4 On 30 November 2015, I made orders giving effect to the reasons for judgment in the following terms: 3. The objection decision made by the respondent on 30 October 2013 is varied by substituting the figure $31,606,820 for $44,146,103. 4. The proceeding is otherwise dismissed. 5. The respondent is to vary the applicant's assessment on the basis that the applicant's taxable income for the year ending 30 June 2008 was the amount of $24,727,777. 6. The respondent is to pay to the applicant any refund due as a consequence of the judgment delivered on 7 October 2015 within 60 days of the date of these orders being entered, together with any interest on that amount. 5 Judgment on costs was reserved. 6 These reasons concern only the question of costs on which the parties made oral submissions on 30 November 2015 and 4 December 2015.

2. BACKGROUND 7 The issues on the substantive appeal can be summarised as follows: (1) Whether: (a) Article 12(4) of the Indian Agreement gives priority to Article 7 with the result that the question of whether Australia had the right to tax income derived from the Indian Services or some part thereof fell to be determined exclusively by reference to the limited force of attraction rule in Article 7, as the applicant contended; or (b) Article 12(4) did not give priority to Article 7 save where, relevantly, Australia had the right to tax business profits under Article 7(1)(a) on the ground that they were attributable to the permanent establishment of the non-resident enterprise and, therefore, as it was not in issue that Article 7(1)(a) did not apply, the starting point was whether the payments for the Indian Services constituted "royalties" within Article 12(3) (the treaty architecture argument). Only in the event that the payments were not "royalties" would it become, in the Commissioner's submission, necessary to consider whether the payments fell within Article 7(1)(b). (2) Whether, accepting the Commissioner's treaty architecture argument, payments for all or some of the nine categories of Indian Services constituted "royalties" within the meaning of Article 12(3)(g), as the Commissioner contended (the Article 12 issue). (3) In the alternative, whether, as the Commissioner contended, the income earned from the provision of Indian Services was liable to taxation by Australia on the ground that Article 7(1)(b) allocated the right to Australia to tax profits attributable to business activities of the same or a similar kind as those carried on through the enterprise's permanent establishment irrespective of where those activities (other than sales) take place (the Article 7 issue). 8 The Commissioner's treaty architecture argument was not addressed by the Commissioner in his Objection Decision which took Article 7 as its starting point. That argument was raised for the first time in oral submissions in the middle of the afternoon on the second day of trial. While the delay in raising the treaty architecture argument did not extend the hearing beyond the original three day estimate (with the hearing in fact finishing early on the third day), it was necessary to make orders for the filing of amended submissions by the parties so as to require the Commissioner to set out his new argument in writing, and to permit the applicant to file amended written submissions in response. 9 In the event, the Commissioner succeeded on the treaty architecture argument, being the first step in his Article 12 submission. He also succeeded in part on the second step, namely, that payments for some of the categories of Indian Services constituted "royalties" within the meaning of Article 12(3)(g). Those payments held to constitute royalties for the purposes of the Indian Agreement amounted to approximately 70 per cent of the relevant amount. Nonetheless, the applicant did achieve a result whereby the relevant amount was reduced from $44,146,103 to $31,606,820. Counsel for the applicant also stated from the Bar Table without objection that the decision would result in reductions in taxable income for the applicant for subsequent financial years until the Indian Agreement was amended. 10 I also considered in Tech Mahindra (No 1) in the alternative, whether the payments would have been taxable in any event in Australia under Article 7 of the Indian Agreement. On this ground, I agreed with the applicant's submission that the profits from the Indian Services in the relevant year would not have been liable to taxation by Australia under Article 7. The Commissioner's arguments to the contrary were rejected. 11 The result of my decision was that the Commissioner had erred in his Objection Decision in finding that the relevant amount was taxable by Australia under Article 7 and in finding in the alternative, if the payments were not caught by Article 7(1)(b), that the whole of the relevant amount was taxable under Article 12(3).

3.1 General principles 12 The Court has power to award costs in all proceedings under s 43 of the Federal Court of Australia Act 1976 (Cth) (Federal Court Act). Without limiting that discretion, the Court has express power to make different awards of costs in relation to different parts of a proceeding, to order the parties to bear costs in specified proportions, and to award costs in favour of or against a party whether or not the party is successful in the proceeding (s 43(3)(b), (c) and (e) respectively). 13 While the question of costs is a matter for the Court's discretion, the general rule is that a successful party is entitled to its costs: Ruddock v Vadarlis (No 2) [2001] FCA 1865; (2001) 115 FCR 229 at 234-235 [11] (Black CJ and French J); Scott v Secretary, Department of Social Security (No 2) [2000] FCA 1450 at [2] (Beaumont and French JJ). In Hughes v Western Australian Cricket Association (Inc.) (1986) ATPR 40-748 at 48,136, Toohey J observed that the discretion must be exercised judicially and identified three principles as to the exercise of the discretion evident from the authorities: 1. Ordinarily, costs follow the event and a successful litigant receives his costs in the absence of special circumstances justifying some other order. Ritter v. Godfrey (1920) 2 K.B. 47. 2. Where a litigant has succeeded only upon a portion of his claim, the circumstances may make it reasonable that he bear the expense of litigating that portion upon which he has failed. Forster v. Farquhar (1893) 1 Q.B. 564. 3. A successful party who has failed on certain issues may not only be deprived of the costs of those issues but may be ordered as well to pay the other party's costs of them. In this sense, "issue" does not mean a precise issue in the technical pleading sense but any disputed question of fact or of law. Cretazzo v. Lombardi (1975) 13 S.A.S.R. 4 at p. 12.

3.2.1 The Commissioner's submissions 14 The Commissioner first contended that the applicant should pay the Commissioner's costs for the reasons that the Commissioner was largely successful in the result, with approximately 70 per cent of income from the Indian Services being found to be taxable as royalties by Australia under the Indian Agreement as enacted. The ordinary rule as to costs should, in other words, apply. 15 At the first hearing on costs on 30 November 2015, the Commissioner put an alternative position that the applicant receive its costs in preparing the amended written submissions after the hearing. He indicated in the further alternative that he may agree to an order that the applicant pay the Commissioner 70 per cent of his costs, while the Commissioner pay the applicant 30 per cent of its costs. The latter was put forward following indications in arguendo that such a split might reflect the extent to which the respective parties were successful (assuming that a costs apportionment was appropriate), while taking account of the fact that the extensive evidence led by the applicant from witnesses resident in India related primarily to the Article 12 issue on which the Commissioner was largely successful. It was also submitted that such an order would compensate the applicant for the costs thrown away by the delay in raising the treaty architecture argument. However, after I had reserved the judgment on costs, the Commissioner requested that the matter be re-opened in order to put further short oral submissions on the basis that the split suggested would not achieve the object which had been raised in the course of argument. 16 At the second costs hearing on 4 December 2015, the Commissioner explained that the parties had exchanged information in the interim about the total costs which each party calculated had been incurred by them in the proceedings. Those estimated by the applicant were in the order of $758,000, while those estimated by the Commissioner were in the order of $270,000, both figures being inclusive of GST. As a consequence, the Commissioner submitted that, even applying (for example) a factor of 65 per cent so as to adjust the figures to those which might be awarded on a taxation, the respective costs liabilities were such that the Commissioner would receive nothing from the applicant towards his costs, while having to pay monies to the applicant towards its costs. In other words, despite being successful, the Commissioner would end up "in the red" on the issue of costs and potentially significantly so. There was no issue taken with the correctness of the Commissioner's analysis in this regard. 17 In the circumstances, the Commissioner submitted that, if the Court was not minded to apply the ordinary rule as to costs, two further options should be considered: (1) the applicant pay 70 per cent of the Commissioner's costs as agreed or assessed, with the 30 per cent reduction in the amount of costs otherwise payable effectively compensating the applicant for its success on the Article 7 issue and partial success on the Article 12 issue; or (2) the applicant pay the Commissioner's costs pertaining to the Article 12 issue, while the Commissioner is to pay the applicant's costs pertaining to the Article 7 issue. 18 In my view, the Commissioner rightly submitted that the second option at [17(2)] above would require a difficult and, in all likelihood, lengthy and contentious costs assessment, given that considerable costs were incurred and the likely difficulties in disentangling those costs incurred with respect to Article 12 issues from those incurred with respect to the Article 7 issue. As a result, I have not considered this option further. 19 In addition, the Commissioner initially submitted at the second costs hearing that the proposed order that the applicant pay 70 per cent of the Commissioner's costs would adequately compensate the applicant for costs thrown away on the late raising of the treaty architecture argument. However, in the course of argument, the Commissioner accepted that it may be appropriate for a further order to be made to the effect that the Commissioner pay the applicant's costs thrown away on this issue.

3.2.2 The applicant's submissions 20 The applicant's primary submission as reflected in their proposed minutes of order is that the Commissioner should pay one half of the applicant's costs. The applicant also appeared to accept in oral argument that in fairness the applicant ought also to pay one half of the Commissioner's costs. However, at the second costs hearing in responding to the Commissioner's submission set out above at [16], the applicant contended that the applicant should pay 70 per cent of the Commissioner's costs, and the Commissioner should pay 25 per cent of the applicant's costs. In support of these submissions, the applicant pointed to the following considerations. (1) There were two main issues in the case, namely, the Article 12 issue, including the treaty architecture argument, and the Article 7 issue. The Commissioner was largely (but not wholly) successful on the first issue and was unsuccessful on the second. (2) While the Commissioner's treaty architecture argument was accepted as correct (Tech Mahindra (No 1) at [62]-[83]), the Commissioner raised that argument only on the second day of the hearing at approximately 3.00pm, after the applicant had filed written submissions and made its oral submissions in chief. As a consequence, the parties were required to file and serve amended submissions after the hearing. It was only, therefore, after the hearing that the Commissioner put the treaty architecture argument into writing for the first time. Furthermore, the late raising of the argument deprived the applicant of the opportunity to research and analyse all of the international authorities which might have borne on the issue of construction that underpinned the treaty architecture argument. (3) The applicant incurred a disproportionate amount of the costs as the onus lay upon it to establish that the assessment was excessive, whereas the Commissioner was required merely to respond to the applicant's case and therefore incurred significantly lower costs. 21 The applicant also submitted that the Commissioner should pay the costs of the second costs hearing on 4 December 2015. I deal with this submission separately.

3.3 What order as to costs should be made? 22 In my view, subject to certain qualifications, it is reasonable and fair in all of the circumstances for the applicant to pay 70 per cent only of the Commissioner's costs excluding any costs incurred by the Commissioner in the preparation of amended written submissions after the hearing and the costs of the hearing on 4 December 2015. 23 In reaching this view, I have had regard to a number of considerations. 24 First, the starting point is that the ordinary rule as to costs should apply, absent special circumstances. 25 Secondly, while the Commissioner was substantially successful to the extent that 70 per cent of the relevant amount was held to be taxable, the applicant was also successful in reducing the amount of taxable income earned through the provision of the Indian Services by 30 per cent. In these circumstances it is not appropriate in my view to award the Commissioner all of his costs but only a proportion of his costs which broadly reflects the extent of his ultimate success in terms of the amount of taxable income vis a vis the applicant. 26 Thirdly, it was not in dispute that the bulk of the evidence led by the applicant related to the Article 12 royalty issue on which the applicant was largely unsuccessful. Otherwise the evidence was primarily directed towards establishing the income earned by the provision of the Australian and Indian Services respectively, with the Commissioner accepting the applicant's calculations in his Objection Decision and in Tech Mahindra (No 1). I accept in this regard, the Commissioner's submission that these factors tell against any order requiring the Commissioner to pay any proportion of the applicant's costs. I also note that the applicant's alternative suggestion that the Commissioner pay 25 per cent of the applicant's costs was still likely to lead to a result whereby the Commissioner effectively received no compensation for his costs and quite possibly would pay more to the applicant in costs than he would receive. 27 In this regard, it is difficult with respect to give much weight to the applicant's submission that its costs were disproportionately greater than those incurred by the Commissioner because the onus lay upon it to prove its case and therefore a further order should be made that the Commissioner should pay part of the applicant's costs. It is true that the evidence led by the applicant was extensive and required considerable analysis, and that two of the three witnesses for the applicant, together with the applicant itself, were resident in India, no doubt adding significantly to the costs. However, that evidence was in the applicant's possession and not the Commissioner's, and was led by the applicant in order to discharge its onus under s 14ZZO(b)(i) of the TAA to prove that the assessment was excessive. The applicant's position in this regard is no different from that of any other applicant challenging an assessment under Part IVC of the TAA. 28 On the other hand, I consider that the Commissioner should be required to pay the applicant's costs thrown away as a result of the late raising of the treaty architecture argument, including all of the costs incurred by the applicant in preparing amended written submissions after the hearing. In this regard, part of the Commissioner's ultimate success is attributable to his success in the treaty architecture argument which, it will be recalled, was put only in the course of oral address after the applicant had put his case in chief in written submissions and orally. This understandably, as I said in Tech Mahindra (No 1) at [47], drew criticism from the applicant, notwithstanding that the argument raised a question of law only. In addition, the fact that the argument was raised only at the hearing meant that there was a need for the parties to amend their written submissions after the hearing. Nor had the treaty architecture argument formed the basis of the decision by the Commissioner on the Objection Decision, which decided the objection in the first instance on the ground that the Indian Services were taxable under Article 7 and only in the alternative under Article 12. In these circumstances, I consider that this is a case where the Commissioner should bear the burden of the applicant's costs which were unnecessarily incurred as a result of the Commissioner's late change in position. 29 However, given that an award of costs is compensatory in the sense that it is intended to indemnify the successful party, I do not accept that the Commissioner's conduct in this regard could support any greater award of costs to the applicant (Oshlack v Richmond River Council (1998) 193 CLR 72 at 89 [44] (Gaudron and Gummow JJ) and 122 [134(6)] (Kirby J); see also ibid at 75 [1] (Brennan CJ) and 97 [67] (McHugh J) (in dissent but not on this point)). I also note that no order for indemnity costs is sought. Further, I do not consider that the applicant's submission that it was thereby deprived of the opportunity of researching and considering the international authorities should sound in some greater award of costs, at least on the material at this stage. While ss 37M and 37N of the Federal Court Act reinforce the requirement for parties to ensure that pleadings give fair notice of their respective positions, the applicant proposed a period of ten days within which to file amended submissions following receipt of the Commissioner's submissions as amended and updated to reflect the new argument, and did not suggest that any longer period was required. 30 In this regard, I have specified that the applicant's costs thrown away include the preparation of the amended submissions after the hearing notwithstanding that the amendments made to the applicant's written submissions were not limited to responding to the treaty architecture argument but included additional references to the small amount of further evidence at trial. In my view it is fair to ensure that the applicant receives the whole of its costs for the amended written submissions as it would have been unnecessary for any amended and updated submissions to be filed after the hearing save for the late raising of the treaty architecture argument. For the same reason, I consider that the Commissioner should not be entitled to any costs for the preparation of his amended and updated written submissions after the trial: Latoudis v Casey (1990) 170 CLR 534 at 565-566 (Toohey J). 31 Finally, I note that the applicant submitted that to make an award in the applicant's favour of costs thrown away by reason of the Commissioner's late treaty architecture argument, as opposed to awarding the applicant a percentage of its costs, would potentially open the door to a complex assessment on the issue of costs. With respect, I am not persuaded that that would be so. The applicant would have put the same arguments on Articles 7 and 12(3) as were made in its original written submissions irrespective of the Commissioner's treaty architecture argument. The late raising of the treaty architecture argument simply added a further issue which the applicant was required to meet. Consistently with this, the applicant identified in oral argument only the amended written submissions, together with work undertaken by the applicant's legal representatives overnight after the issue was raised, as costs wasted by reason of the delay in the argument being raised, albeit that the applicant was endeavouring to illustrate only wasted costs and resources rather than committing itself to an exhaustive list.

3.4 The costs of the second costs hearing on 4 December 2015 32 The applicant also submits that the Commissioner should pay the applicant's costs of the second costs hearing on 4 December 2015 on the ground that the Commissioner requested that the matter be relisted. However, the Commissioner made that request only after an email exchange between the parties disclosed the practical implications of an order being made that the Commissioner pay 30 per cent of the applicant's costs. The possibility of such an order being made had been raised in arguendo at the first costs hearing: see above at [15]. It is fair to infer that the figures disclosed in the emails significantly altered the assumption on which the Commissioner had been proceeding for the purposes of argument at the first costs hearing as to the likely consequences of an order in the terms raised at that time. I consider that the Commissioner acted reasonably in these circumstances in requesting that the matter be called back on for further oral argument but equally consider that it would not be fair to require the applicant to pay in effect for the Commissioner's erroneous earlier assumption. In all of the circumstances, I consider that the fairest course is to make no order as to the costs of the second costs hearing.

4. CONCLUSION 33 For the reasons set out above, I consider that the applicant should pay 70 per cent of the Commissioner's costs excluding any costs incurred by the Commissioner in the preparation of amended written submissions after the hearing. I also consider that the Commissioner should be required to pay the applicant's costs thrown away as a result of the late raising of the treaty architecture argument, including all of the costs incurred by the applicant in preparing amended written submissions after the hearing. There should be no order as to the costs of the hearing on 4 December 2015. I certify that the preceding thirty-three (33) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Perry.