Orica Limted vs Commissioner of Taxation [2015] FCA 1399

Schemes Reducing Income Tax

This is a summary of the tax scheme engaged in by Orica from 2004 to 2006.  The figures are not meant to be exact and the descriptions of events are highly simplified.

There are four companies of concern in this case.

Orica Limited - A publically listed Australian mining services company.  It is referred to as 'Orica' in this case.

Orica Finance Limited - A subsidiary of Orica Ltd.  It is referred to as 'OFS' in this case.

Orica Explosives Holdings Pty Ltd - A subsidiary of Orica.  It is referred to as 'OEH' in this case.

Orica US Services Inc - An American subsidiary of OEH.  It is referred to as 'OUSSI' in this case.

Part IVA

The question to be determined in this case is whether or not in 2004, 2005 and 2006 Orica's tax arrangements contravened Part IVA of the Income Tax Assessment Act 1936.  Part IVA provides that where there is:

A scheme,
giving rise to a tax benefit,
entered into for the 'dominant' purpose of obtaining that benefit.

The commissioner may remove the tax benefits obtained by a taxpayer by amending their return.

Section 23AJ

As it existed in the relevant years, s.23AJ allowed subsidiary companies to pay their Australian 'head company' dividends which would be completely non-assessable for tax purposes.

Tax Consolidated Group

Orica is the head company of a tax consolidated group, consisting of its Australian entities.  For tax purposes, Orica, OEH and OFL are considered to be part of the same entity.  Thus, if OFL make an interest payment, it is deductible by Orica.

Tax Losses

OUSSI had accumulated roughly USD$50m of tax losses in the United States due to a poorly performing North American explosives market.  (Probably close to AUD$75m)

The Scheme

The gist of the scheme is as follows.  All figures are ball-park numbers, in AUD currency.

OUSSI issued 500 million preference shares @ $1 each to OEH.

OEH transferred $500m to OUSSI.

OUSSI loaned $500m to OFL.  The interest rate was 5% ($25m).

OFL paid OUSSI $25m in interest per annum on that loan.  Orica deducted that $25m from it's taxable income in Australia - being from the same 'tax group' as OFL.

OUSSI offset its $25m interest income against unrealised tax losses.  OUSSIs tax on this income is zero.

OUSSI paid a dividend of $25 million to OEH. Non-assessable due to s.23AJ.

In summary:  A tax deduction is claimed, and the money returns without a tax bill in the USA or Australia.

This cycle repeated for three years until the US tax losses were totally utilised ($25m x 3 = $75m).  After which the loans were discharged and the equity returned.

Note (1) there are withholding tax obligations that don't ultimately impact on the above tax result.

Note (2) returning the $500m in equity back to Orica required an intricate shareholding structure, and careful timing, which was possible without ultimately impacting on the above tax result.

Did Part IVA apply

"The Commissioner contended, and Orica conceded, that the tax deductions claimed for the interest incurred by OFL in each of the three years in question were tax benefits within the meaning of s 177C(1)(b) and that they had been obtained in connection with schemes within the meaning of Part IVA." ¹

The remaining question is:  What was the dominant purpose for entering into the scheme?

The Parties' Contentions

"It was submitted for Orica that the tax deductions for the interest incurred by OFL were not the “ruling, prevailing, or most influential purpose” because from an accounting point of view the reported profits were not more attributable to any one of the three accounting components of the transactions as set out in the joint expert report. Mr Holland [The ATO expert] expressed the opinion that the deductions for the interest expense were “the reason for the increase in reported profits of $33.8 million”. Mr Stevenson [Orica's expert], in contrast, at paragraph 13 of the joint report, said that he was of the view that there was “no accounting perspective” for choosing between the three components of the transactions to determine which of them led to the increase in the reported profits of the Orica group." ²

In summary, Orica contended that utilising US tax losses, as opposed to writing them off, made accounting sense, and hence why this was predominantly an accounting decision.  In Orica's view there was no logical reason for the Commissioner to treat tax considerations above their accounting priorities.

In the Commissioner's view, the prevailing tax benefit was the dominant purpose of the transaction.

The key points of Justice Pagone's decision are summarised below.

The Decision

"The application of s 177D requires, rather, having regard to the eight matters in s 177D(b) to determine whether “it would be concluded” from those matters that a person who entered into or carried out the scheme did so for the dominant purpose of enabling the taxpayer to obtain a tax benefit in connection with the scheme. The conclusion to be reached is not a finding on the evidence that one of the persons contemplated by the section had the requisite purpose but that such a purpose is to be attributed to one of those persons by analysis of objective criteria without regard to the actual purpose or motive, ultimate or otherwise, of the relevant scheme participants...  Thus, for example, the inquiry called for by s 177D is not answered in the Commissioner’s favour by evidence of the description of the proposal as found in the 8 February 2002 initiative action template that the proposal would “[r]ealise reduced tax charges through utilisation and recognition of US tax losses”. The actual motive may explain why the taxpayers “acted as they did” but, as Gummow and Hayne JJ observed in [Hart v FCT] it does not provide an answer to the question posed by s 177D(b) which “does not require, or even permit, any inquiry into the subjective motives of the relevant taxpayers or others who entered into or carried out the scheme or any part of it”." ³

"The tax benefit was obtained by the interest payable upon the loan from OUSSI to OFL. That, for the reasons above, was “the ruling, prevailing, or most influential” purpose which overshadowed any other purpose which the schemes may have had. The utilisation of the US tax losses by Orica in this case, and their re-recognition, required the creation of a virtually certain source of income. The losses had been incurred in the US but would remain unutilised unless and until the economic benefit of the US tax losses could be enjoyed by the group by the US company deriving taxable profits. It was clear at the time that the US operations could not take advantage of the US losses by normal operation of the US business. Circumstances could be created for the US subsidiary to derive income to offset against the US tax losses but the use of the US tax losses would be of no economic benefit to the group unless the US losses had the effect of reducing the tax otherwise payable by the group on income which could not otherwise be sheltered by the US tax losses." ⁴

"Orica’s appeals against the Commissioner’s application of Part IVA will accordingly be rejected." ⁵

Notes

The case:  http://www.austlii.edu.au/au/cases/cth/FCA/2015/1399.html

1.  p15
2.  p23
3.  p19
4.  p33
5.  p34