St George Bank v Federal Commissioner of Taxation
Document type: Decision Impact Statement
Venue: Federal Court of Australia (NSD 617-21 of 2008)
Judgment date: 25 May 2009
Date published: 11 March 2010
Decision outcome: Favourable

Summary of decision:
Outlines the Tax Office's response to this case which concerned deductions claimed for interest payments under a debenture that was connected with the raising of additional capital by the appellant to meet the capital adequacy requirements of the Reserve Bank of Australia ("RBA").

Overview of facts:
St George Bank Limited ("St George") was required by the RBA to increase its Tier 1 capital after acquiring the Advance Bank Australia Limited. | It did so by implementing an arrangement called "US$ Tax Deductible Perpetual Preferred". The arrangement involved establishing a special purpose company in the US ("LLC") which issued capital securities to US investors; the proceeds of the sale were invested in debentures issued by St George; and the interest paid on the debentures was used to fund the payment of dividends on the capital securities. | Relevant aspects of the various agreements included that: • The sole purpose of the LLC was to issue the capital securities and to invest the proceeds in the debentures. The interest obligations under the debentures mirrored the dividend obligations under the capital securities. • The obligation to pay interest under the debenture was contingent upon the appellant being solvent, which had the effect that the interest on the debenture could be subordinated to any dividend payable to shareholders of the appellant. • The obligation imposed on LLC to pay the dividend in respect of the capital securities only arose if St George had paid the corresponding amount of interest to LLC. • The effect of the agreements was that the funds advanced by the holders of the capital securities would never leave the St George Group. • The $250 million of capital raised by issue of the capital securities would satisfy the Tier 1 capital requirements of the RBA. | • The sole purpose of the LLC was to issue the capital securities and to invest the proceeds in the debentures. The interest obligations under the debentures mirrored the dividend obligations under the capital securities. • The obligation to pay interest under the debenture was contingent upon the appellant being solvent, which had the effect that the interest on the debenture could be subordinated to any dividend payable to shareholders of the appellant. • The obligation imposed on LLC to pay the dividend in respect of the capital securities only arose if St George had paid the corresponding amount of interest to LLC. • The effect of the agreements was that the funds advanced by the holders of the capital securities would never leave the St George Group. • The $250 million of capital raised by issue of the capital securities would satisfy the Tier 1 capital requirements of the RBA. | St George lodged an election that Division 974 of the Income Tax Assessment Act 1997 (ITAA 97) would apply to the debenture but subsequently argued that the election was invalid. | The Full Federal Court dismissed the appellant's appeal and the High Court refused to grant St George special leave to appeal on 3 November 2009. | Issues decided by the court or tribunal | Deductibility of the "interest" | Justice Perram, with whom Justices Emmett and Stone agreed, concluded that the payments of interest were of a capital nature and thus not deductible. | His Honour agreed with the trial judge about the nature of the debenture and the capital securities and held that the payments of interest were an essential element in an overall transaction to raise capital and that it was appropriate in the circumstances not to limit the focus to just the debenture, but to examine the wider context to ascertain the nature of the advantage sought by the payments for the purposes of paragraph 8-1(2)(a). His Honour concluded that the advantage sought by the payments of interest was the acquisition of permanent capital which was a structural advantage of a lasting character in accordance with the tests set out in Sun Newspapers Ltd v FCT . | Validity of the election | The Court was of the view that as the payments were denied deductibility by being of a capital nature, it was not strictly necessary to consider the election issue but as it had been argued fully before the trial judge and on appeal they would consider it. | Justice Stone, with whom Justices Emmett and Perram agreed, concluded that the election was invalid as certain information required was not provided. Her Honour agreed with the trial judge that the election was stated to be effective only if certain information was provided and, as that did not occur, the election was invalid.

Issues decided:
Deductibility of the "interest": Justice Perram, with whom Justices Emmett and Stone agreed, concluded that the payments of interest were of a capital nature and thus not deductible. His Honour agreed with the trial judge about the nature of the debenture and the capital securities and held that the payments of interest were an essential element in an overall transaction to raise capital and that it was appropriate in the circumstances not to limit the focus to just the debenture, but to examine the wider context to ascertain the nature of the advantage sought by the payments for the purposes of paragraph 8-1(2)(a). His Honour concluded that the advantage sought by the payments of interest was the acquisition of permanent capital which was a structural advantage of a lasting character in accordance with the tests set out in Sun Newspapers Ltd v FCT . | Validity of the election: The Court was of the view that as the payments were denied deductibility by being of a capital nature, it was not strictly necessary to consider the election issue but as it had been argued fully before the trial judge and on appeal they would consider it. Justice Stone, with whom Justices Emmett and Perram agreed, concluded that the election was invalid as certain information required was not provided. Her Honour agreed with the trial judge that the election was stated to be effective only if certain information was provided and, as that did not occur, the election was invalid.

ATO view of decision:
The decision was in accordance with established principles and is consistent with the Commissioner's view that a deduction under section 8-1 is not allowable in respect of returns paid for the raising and maintaining of Tier 1 capital for a bank. However, the decision should have little on-going importance in relation to outgoings of the kind considered in this case as the deductibility of such outgoings is now determined by reference to the rules on the tax treatment of gains and losses from financial arrangements contained in Division 230 of the ITAA 97 and debt and equity interests contained in Division 974 of the ITAA 97. | In respect of the Court's view that the election was invalid, we consider that it is confined to the facts of this case and has no impact on the interpretation of elections generally. As the election was in respect of transitional provisions, it has no ongoing impact. Accordingly, there is limited application to other cases.

Administrative treatment:
Implications on current Public Rulings & Determinations | None

Legislative references: Income Tax Assessment Act 1997 8-1 Div 974 New Business Tax System (Debt & Equity) Act 2001 Schedule 1, Item 118
Case references: Commissioner of Taxation v South Australian Battery Makers Pty Ltd 140 CLR 645 52 ALJR 640 21 ALR 59 8 ATR 879 78 ATC 4412 [1978] HCA 32 Commissioner of Taxation v Star City Pty Ltd [2009] FCAFC 19 2009 ATC 20-093 72 ATR 431 175 FCR 39 Macquarie Finance Ltd v Commissioner of Taxation [2005] FCAFC 205 2005 ATC 4829 146 FCR 77 61 ATR 1 225 ALR 694 Project Blue Sky Inc v Australian Broadcasting Authority 194 CLR 355 72 ALJR 841 153 ALR 490 [1998] HCA 28 Steele v Deputy Commissioner of Taxation 197 CLR 459 73 ALJR 437 41 ATR 139 161 ALR 201 99 ATC 4242 [1999] HCA 7 Sun Newspapers Ltd v Federal Commissioner of Taxation 61 CLR 337 5 ATD 87 [1939] ALR 10 12 ALJ 411 Ure v Federal Commissioner of Taxation [1981] FCA 9 34 ALR 237 50 FLR 219 11 ATR 484 81 ATC 4100
Subject references: Allowable deductions Interest payments Capital or of a capital nature Capital adequacy ratios