Commissioner of Taxation v Messenger Press Pty Ltd
Document type: Decision Impact Statement
Venue: Federal Court of Australia (NSD 1257 of 2012)
Judgment date: 25 July 2013
Date published: 17 April 2014

Summary of decision:
Outlines the ATO's response to this case which concerns whether a currency exchange loss was incurred under former Division 3B of the Income Tax Assessment Act 1936 on the discharge by a company of USD indebtedness to its subsidiary.

Overview of facts:
In 1989 The News Corporation Limited (TNCL), incorporated in Australia, was the parent company of the News group; News Finance Pty Ltd (NF), News Limited (NL) and News Publishing Holdings Pty Ltd (NPHP) were wholly owned subsidiaries and News Publishing Investments Pty Ltd (NPIP) was a subsidiary of NPHP. | NL had built up a large debt (its capital and reserves were negative $239 million) in funding the foreign expansion of the News Group through its interest in News Publishers Limited (NPL) incorporated in Bermuda. NL was a borrower and guarantor of external debt and its accounts were publicly disclosed. To address this problem, News group undertook a reorganisation with the objective of reducing NL's debt. | On 31 May 1989, pursuant to a Standby Credit Agreement, NF loaned $2,974,708,426 to NPHP which used the funds to subscribe for shares in NPIP. NF and NPHP accounted for this transaction as three separate loans in AUD, USD and GBP although the cheque was in AUD. NPIP then used the funds to acquire NL's interest in NPL and NL used the proceeds of that sale to retire debt. | In 1991 the News group undertook a global reorganisation of its operations in response to a downturn in the economy and a liquidity crisis. The restructure involved NPIP disposing of its interest in NPL by that company redeeming and buying back the redeemable preference shares and ordinary shares held by NPIP and assigning or endorsing a series of promissory notes to various companies within the News Australia group. Relevant aspects of the transactions to give effect to this reorganisation include: 1. NPL issued an unsecured demand note in favour of NPIP for the sum of USD$3,020,000,000. NPL then endorsed 15 promissory notes of various currencies (AUD, USD, GBP & DM ) to NPIP 2. NPHP issued an unsecured demand note in favour of NPIP for the sum of USD$2,847,080,544. The note was expressed to be issued "in consideration" of NPIP making a loan of that amount to NPHP and was payable on demand to the bearer of the note. NPIP then endorsed 7 of the promissory notes referred to above to NPHP 3. NPHP then endorsed 5 of the notes to NF which had the effect of discharging the 1989 loan under the standby credit agreement (News claims this was a novation not a discharge). | 1. NPL issued an unsecured demand note in favour of NPIP for the sum of USD$3,020,000,000. NPL then endorsed 15 promissory notes of various currencies (AUD, USD, GBP & DM ) to NPIP 2. NPHP issued an unsecured demand note in favour of NPIP for the sum of USD$2,847,080,544. The note was expressed to be issued "in consideration" of NPIP making a loan of that amount to NPHP and was payable on demand to the bearer of the note. NPIP then endorsed 7 of the promissory notes referred to above to NPHP 3. NPHP then endorsed 5 of the notes to NF which had the effect of discharging the 1989 loan under the standby credit agreement (News claims this was a novation not a discharge). | Various other transactions between NPIP and NPHP had occurred between 1991 and 2002 with the result that at 28 June 2002, NPHP was indebted to NPIP on intercompany account for USD3,481,527,042 and NPIP owed NPHP AUD7,403,425,151 | On 8 June 2001, NPHP purchased two USD promissory notes (USD750m and USD265m) from TNCL for AUD1,983,453,267 and endorsed them to NPIP in partial reduction of the 1991 loan. | On 28 June 2002, NPIP issued two promissory notes for USD3,481,527,042 and AUD1,230,504,849 to NPHP in satisfaction of its indebtedness. NPHP then presented the USD3,481,527,042 note to NPIP on the basis that the liability of NPHP to NPIP would be satisfied by set off against the liability of NPIP to NPHP on that note. | NPHP claims a forex loss of $2,097,553,323 occurred when it endorsed the two USD promissory notes (USD750m and USD265m) to NPIP in 2001 and when it presented the USD3,481,527,042 promissory note to NPIP in 2002 in final satisfaction of the 1991 loan. | Issues decided by the court | There were essentially two issues for the Full Court to determine in the appeal. First, whether there had been a realisation of a currency exchange loss and secondly, whether any such loss had been incurred under an eligible contract as required by Division 3B. | 1. Realisation of a currency exchange loss | The Commissioner had submitted, in reliance on the decision of the High Court in Commissioner of Taxation v Energy Resources of Australia Ltd (1996) 185 CLR 66 ("ERA") that the primary judge had erred in concluding that a currency exchange loss could be realised without a related exchange, being necessarily a payment or outgoing involving exchanges of foreign and Australian currency. The Commissioner argued that more was required than an exchange of promissory notes and an extinguishment of liabilities in foreign currencies. In the present case, the discharge of NPHP's US dollar indebtedness was done by the tender and acceptance of promissory notes denominated in US dollars. | The Full Court quoted extensively from the Explanatory Memorandum for the Bill that introduced the 1987 amedment, noting that the purpose of the amendment was to remove the distinction between revenue and capital account in the area of foreign exchange gains and losses. | Their Honours relied on the fact that the term "currency exchange loss" was defined in section 82Z as "a loss to the extent to which it is attributable to currency exchange rate fluctuations". Considering the definition, the loss must be attributable to fluctuations in the the currency exchange rate; that is to say, "currency exchange is now read as adjectival apropos rate" and noted that the Explanatory Memorandum also supported that interpretation. Had it not been so defined they acknowledged that an argument that an actual exchange of currency was required for the section to be activated might have a plausible basis. | The Full Court considered the High Court's reasoning in ERA and distinguished it on the basis that the High Court was referring to a hypothetical taxpayer and identifying a paradigm instance of a currency exchange gain or loss, which was a tool in their reasoning process rather than defining the limits of Div 3B or saying anything about what might constitute a sufficient exchange transaction on other facts. Their Honours held that the circumstances of the present case take it outside anything said by the High Court in ERA.. | Their Honours decided that a relevant loss had been realised for the purposes of paragraph 82V(2)(b) in June 2001, when the promissory notes totalling USD1,023,453,698 (which had been purchased the same day by NPHP for AUD1,983,453,267) had been accepted by NPIP in partial discharge of the debts. If an "exchange transaction" were required, this was satisfied by the exchange of the assets for which NPHP had paid in Australian currency for the discharge of the debt. | Their Honours also accepted that a relevant loss had been realised upon repayment of NPHPs remaining debt to NPIP in June 2002. Their Honours held that NPHP's tender of NPIP's own promissory note of USD3,481,527,042, (which NPHP had earlier that same day accepted in satisfaction of NPIP's debt to it of AUD6,172,920,292) was sufficient to realise a loss. This was because NPHP had obtained the promissory note for a consideration measured in Australian dollars and due to the adverse movement in the exchange rate this sum was more than the Australian dollar benefit which NPHP had originally derived from obtaining the funds on loan. | Their Honours considered that whether there was an "exchange or transfer of liabilities" was not responsive to the terms of section 82Z but doubted that anything turned upon the terminology used by the primary judge. They accepted that his Honour was not suggesting that one entity might transfer its liability to a second entity and stated that: 'What matters is whether a difference is made if the taxpayer in question funds the discharge of his or her existing foreign currency debt by supplying a note obtained in return for an increase in his or her Australian currency borrowings rather than borrowing Australian money as such and using that money to discharge the debt. The primary judge considered not and we agree .'" | In respect of the repayment in June 2002, their Honours noted the facts were different but the same conclusion should be reached as NPHP used an asset denominated in Australian dollars (the debt owing to it by NPIP) to obtain a note which the creditor (NPIP) was prepared to accept in discharge of the US dollar debt. | 2. Under an eligible contract | The Full Court, relying on what it had said earlier in respect of a realisation of a loss, stated that: '... once it is held as we would for reasons given above, that Div 3B does not require there to have been an exchange of currency as such, the proposition that an admitted loss should not be regarded as having been incurred " under " an admittedly eligible contract because the contract neither required not facilitated an exchange of currency becomes an untenable one .'

Issues decided:
There were essentially two issues for the Full Court to determine in the appeal. First, whether there had been a realisation of a currency exchange loss and secondly, whether any such loss had been incurred under an eligible contract as required by Division 3B. 1. Realisation of a currency exchange loss The Commissioner had submitted, in reliance on the decision of the High Court in Commissioner of Taxation v Energy Resources of Australia Ltd (1996) 185 CLR 66 ("ERA") that the primary judge had erred in concluding that a currency exchange loss could be realised without a related exchange, being necessarily a payment or outgoing involving exchanges of foreign and Australian currency. The Commissioner argued that more was required than an exchange of promissory notes and an extinguishment of liabilities in foreign currencies. In the present case, the discharge of NPHP's US dollar indebtedness was done by the tender and acceptance of promissory notes denominated in US dollars. The Full Court quoted extensively from the Explanatory Memorandum for the Bill that introduced the 1987 amedment, noting that the purpose of the amendment was to remove the distinction between revenue and capital account in the area of foreign exchange gains and losses. Their Honours relied on the fact that the term "currency exchange loss" was defined in section 82Z as "a loss to the extent to which it is attributable to currency exchange rate fluctuations". Considering the definition, the loss must be attributable to fluctuations in the the currency exchange rate; that is to say, "currency exchange is now read as adjectival apropos rate" and noted that the Explanatory Memorandum also supported that interpretation. Had it not been so defined they acknowledged that an argument that an actual exchange of currency was required for the section to be activated might have a plausible basis. The Full Court considered the High Court's reasoning in ERA and distinguished it on the basis that the High Court was referring to a hypothetical taxpayer and identifying a paradigm instance of a currency exchange gain or loss, which was a tool in their reasoning process rather than defining the limits of Div 3B or saying anything about what might constitute a sufficient exchange transaction on other facts. Their Honours held that the circumstances of the present case take it outside anything said by the High Court in ERA.. Their Honours decided that a relevant loss had been realised for the purposes of paragraph 82V(2)(b) in June 2001, when the promissory notes totalling USD1,023,453,698 (which had been purchased the same day by NPHP for AUD1,983,453,267) had been accepted by NPIP in partial discharge of the debts. If an "exchange transaction" were required, this was satisfied by the exchange of the assets for which NPHP had paid in Australian currency for the discharge of the debt. Their Honours also accepted that a relevant loss had been realised upon repayment of NPHPs remaining debt to NPIP in June 2002. Their Honours held that NPHP's tender of NPIP's own promissory note of USD3,481,527,042, (which NPHP had earlier that same day accepted in satisfaction of NPIP's debt to it of AUD6,172,920,292) was sufficient to realise a loss. This was because NPHP had obtained the promissory note for a consideration measured in Australian dollars and due to the adverse movement in the exchange rate this sum was more than the Australian dollar benefit which NPHP had originally derived from obtaining the funds on loan. Their Honours considered that whether there was an "exchange or transfer of liabilities" was not responsive to the terms of section 82Z but doubted that anything turned upon the terminology used by the primary judge. They accepted that his Honour was not suggesting that one entity might transfer its liability to a second entity and stated that: 'What matters is whether a difference is made if the taxpayer in question funds the discharge of his or her existing foreign currency debt by supplying a note obtained in return for an increase in his or her Australian currency borrowings rather than borrowing Australian money as such and using that money to discharge the debt. The primary judge considered not and we agree .'" In respect of the repayment in June 2002, their Honours noted the facts were different but the same conclusion should be reached as NPHP used an asset denominated in Australian dollars (the debt owing to it by NPIP) to obtain a note which the creditor (NPIP) was prepared to accept in discharge of the US dollar debt. 2. Under an eligible contract The Full Court, relying on what it had said earlier in respect of a realisation of a loss, stated that: '... once it is held as we would for reasons given above, that Div 3B does not require there to have been an exchange of currency as such, the proposition that an admitted loss should not be regarded as having been incurred " under " an admittedly eligible contract because the contract neither required not facilitated an exchange of currency becomes an untenable one .'

ATO view of decision:
The Full Court concluded that no actual exchange of currency is required in order to realise a 'currency exchange loss'. | The Commissioner had taken the view that the High Court's decision in ERA had so restricted the application of Division 3B that that there were very few transactions to which it could be applied. The decision of the Full Court and the way in which the Full Court distinguished ERA, means that Division 3B may apply to foreign currency liabilities which are discharged using a promissory note (or foreign currency) obtained on that day: • in return for an increase in the taxpayer's Australian currency borrowings, or • in exchange for an asset denominated in Australian dollars. | • in return for an increase in the taxpayer's Australian currency borrowings, or • in exchange for an asset denominated in Australian dollars. | The High Court decision in ERA is still binding authority that no foreign currency exchange gain or loss arises where a taxpayer deals exclusively in foreign currency. The High Court held that "there is nothing in the Act that requires the making of notional conversions of taxpayer's transactions". Absent an exchange transaction, including the kinds of exchange transactions found on the facts of this case, a taxpayer cannot rely on a 'notional' conversion to realise a loss or gain on the discharge of a foreign currency liability. | The Full Federal Court rejected the Commissioner's argument that the contract must require or facilitate an exchange of currency in order for a foreign currency exchange loss to be realised 'under' the contract. While rejecting the primary judge's reliance on the reasoning of the Full Court in ERA, the Full Federal Court did not provide detailed reasons for its decision that the loss in this case was incurred "under" an eligible contract. In the Commissioner's view, the Full Court appears to accept the conclusion of Perram J at first instance that: "... it is sufficient for the purposes of Division 3B for a loss to result from the repayment, as here, of a foreign currency loan when there has been a decline in the value of the Australian dollar . In such cases the loss arises under the loan agreement ". Further, the Full Court did not consider that the Commissioner had challenged the decision of Perram J at first instance that the reference to 'eligible contract' in sections 82Y and 82Z includes a reference to the plural. | A number of ATO Interpretative Decisions and references to Division 3B in a Taxation Determination will be withdrawn following this decision. Division 3B was repealed in 2003 and the Commissioner considers that this decision will have a limited ongoing impact on other taxpayers. As a result, there is no intention to replace the withdrawn ATO precedential documents.

Administrative treatment:
Implications for ATO precedential documents (Public Rulings & Determinations etc) | The following ATOIDs have been withdrawn, as they refer to an interpretation of the High Court decision in ERA which is inconsistent with the decision in this case: • ATO ID 2003/126 • ATO ID 2006/64 • ATO ID 2006/124 • ATO ID 2006/291 • ATO ID 2009/16 • ATO ID 2010/221 | • ATO ID 2003/126 • ATO ID 2006/64 • ATO ID 2006/124 • ATO ID 2006/291 • ATO ID 2009/16 • ATO ID 2010/221 | Paragraph 19 of Taxation Determination TD 2006/57 has been withdrawn. | Taxation Ruling TR 93/8 Income tax: foreign exchange gains and losses of a capital nature - realisation of gains and losses and the meaning of 'eligible contract' in Division 3B was withdrawn on 3 July 1996 following the decision of the High Court in ERA. However, following that decision it was not clear when Division 3B applied. This was so notwithstanding the legislative purpose to bring to account for tax purposes business foreign exchange gains and losses of a capital nature. To alleviate those uncertainties, the former Chief Tax Counsel announced that unless there was clearer legislative or judicial direction on the application of Division 3B, the ATO's practice would be not to disturb assessments which brought to account for tax purposes foreign exchange gains and losses in accordance with the principles established in Taxation Ruling TR 93/8. | The Commissioner considers that the decision of the Full Federal Court represents clearer judicial direction on the application of Division 3B. The ATO practice contained in an article by former Chief Tax Counsel Michael D'Ascenzo that was published in the Weekly Tax Bulletin of 7 April 1997 [Bulletin number 16, paragraph 406] and in similar tax-related publications about that time, is withdrawn and will not apply to any gains or losses realised under Division 3B after 17 April 2014.

Legislative references: Income Tax Assessment Act 1936 (Cth) Part III, Division 3B
Case references: Armco (Australia) Pty Ltd v Federal Commissioner of Taxation [1948] HCA 49 76 CLR 584 Avco Financial Services Ltd v Commissioner of Taxation [1982] HCA 36 150 CLR 510 13 ATR 63 82 ATC 4246 Bank of New South Wales v Brown [1983] HCA 1 151 CLR 514 Caltex Ltd v Federal Commissioner of Taxation [1960] HCA 17 (1959) 106 CLR 205 Colonial Mutual Life Assurance Society Ltd v Federal Commissioner of Taxation [1946] HCA 60 (1946) 73 CLR 604 Commercial and General Acceptance Ltd v Federal Commissioner of Taxation (1977) 137 CLR 373 7 ATR 716 77 ATC 4375 Commissioner of Taxation v Energy Resources of Australia Ltd [1994] FCA 1521 54 FCR 25 29 ATR 553 94 ATC 4923 Commissioner of Taxation v Energy Resources of Australia Ltd [1996] HCA 10 185 CLR 66 33 ATR 52 96 ATC 4536 Royal Insurance Company Ltd v Stephen (1928) 14 TC 22 The Texas Company (Australasia) Ltd v Federal Commissioner of Taxation [1940] HCA 9 (1940) 63 CLR 382 Westminster Bank Ltd v Osler [1933] AC 139
Subject references: currency exchange losses eligible contract realisation of losses