Mills v Commissioner of Taxation
Document type: Decision Impact Statement
Venue: High Court (S225/2012)
Judgment date: 14 November 2012
Date published: 21 January 2013

Summary of decision:
Outlines the ATO's response to this case on whether, in terms of the general anti-avoidance rule in s177EA of the Income Tax Assessment Act 1936 , a Bank had a more than incidental purpose of enabling investors to obtain imputation benefits from the issue of hybrid stapled securities.

Overview of facts:
On 14 October 2009, 10,000,000 "Perpetual Exchangeable Resaleable Listed Securities V" (PERLS V) were issued by the Commonwealth Bank of Australia (the Bank) and transferred to successful applicants at an application price of AUD $200 each. The total capital raised by the PERLS v offering was AUD $2,000 million. | PERLS v are stapled securities each comprising an unsecured subordinated Note issued by the Bank through its New Zealand branch and a Preference Share in the Bank. PERLS v qualified as non-innovative residual Tier 1 capital for regulatory purposes. | Relevant features of the PERLS v securities include: • Until the happening of certain events, scheduled distributions to investors are interest payments on the Note • Distributions are calculated by reference to a benchmark interest rate reduced by the value of the franking benefit provided to investors • To the extent that a distribution is not fully-franked, the Bank will compensate investors by increasing the cash component of the distribution • The securities are scheduled to convert into ordinary shares in the Bank on 31 October 2014 • On conversion, investors will receive a number of shares having approximately the same value as their initial investment | • Until the happening of certain events, scheduled distributions to investors are interest payments on the Note • Distributions are calculated by reference to a benchmark interest rate reduced by the value of the franking benefit provided to investors • To the extent that a distribution is not fully-franked, the Bank will compensate investors by increasing the cash component of the distribution • The securities are scheduled to convert into ordinary shares in the Bank on 31 October 2014 • On conversion, investors will receive a number of shares having approximately the same value as their initial investment | Funds raised through the issue of PERLS v were lent by the New Zealand branch of the Bank to a New Zealand subsidiary or have otherwise been employed in the branch business. The income of the New Zealand branch is exempt from Australian tax under s23AH of the Income Tax Assessment Act 1936 (ITAA36) and the Bank claims deductions for the distributions on the note in New Zealand. | A Determination under s177EA(5)(b) of the ITAA36 was made by the Commissioner on 15 December 2009, to deny imputation benefits attached to a distribution expected to be made in February 2010 to a representative taxpayer. The taxpayer was unsuccessful in challenging the Determination before the Federal Court, and on appeal to the Full Federal Court, but was successful in the High Court. | Issues decided by the court | The issue before the High Court was whether, having regard to relevant circumstances, s177EA applied to deny imputation benefits attached to distributions to investors on the basis that the arrangement was entered into or carried out for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling investors to obtain the imputation benefits. | The High Court unanimously allowed the taxpayers appeal with French CJ, Hayne, Kiefel and Bell JJ agreeing with the reasons of Justice Gageler. | Justice Gageler noted two uncontroversial features of the "relevant circumstances" in s177EA(17). First, that the relevance of the relevant circumstances lies in the extent to which they are probative of the ultimate question as to purpose. Secondly, that while the circumstances referred to in s177EA(17) are not exhaustive, they are mandatory relevant considerations and, where they exist, must be taken into account. However, their degree of relevance will vary according to the extent to which they are probative of the ultimate question. | His Honour identified two questions of construction of s177EA(3)(e) pivotal to the application of s177EA , namely, what amounts to a "purpose of enabling" and when is such a purpose "an incidental purpose". | In considering when a purpose is an incidental purpose, his Honour quoted the statement in the Explanatory Memorandum for s177EA that "a purpose is an incidental purpose when it occurs fortuitously or in subordinate conjunction with another purpose, or merely follows another purpose as its natural incident". His Honour went on to say that a purpose would be an incidental purpose and outside the scope of s177EA(3)(e) "if that purpose does no more than further some other purpose or follow from some other purpose". His Honour said that in adopting that meaning of incidental purpose there was no warrant for further confining the application of s177EA by adopting a strained meaning of the word "enabling" in s177EA(3)(e) (as argued for by the appellant) and that it was best read in the sense suggested by the majority in the Full Federal Court as that of "supplying with the requisite means or opportunities to [that] end" | However, his Honour disagreed with the majority of the Full Federal Court in relation to the construction of s177EA(3)(e) in two respects. At [66] his Honour stated that: "...a purpose can be incidental even where it is central to the design of a scheme if that design is directed to the achievement of another purpose. Indeed, the centrality of a purpose to the design of a scheme directed to the achievement of another purpose may be the very thing that gives it a quality of subsidiarity and therefore incidentality. That is not impermissibly to confine the scope of s177EA(3)(e) to a dominant purpose: the categories of "dominant" and "incidental" are not exhaustive. " and "...counterfactual analysis is not antithetical to the statutory inquiry mandated by s 177EA(3)(e). Purpose is a matter for inference and incidentality is a matter of degree. Consideration of possible alternatives may well assist the drawing of a conclusion in a particular case that a purpose of enabling a holder to obtain a franking credit does or does not exist and, if such a purpose exists, that the purpose is or is not incidental to some other purpose." | and "...counterfactual analysis is not antithetical to the statutory inquiry mandated by s 177EA(3)(e). Purpose is a matter for inference and incidentality is a matter of degree. Consideration of possible alternatives may well assist the drawing of a conclusion in a particular case that a purpose of enabling a holder to obtain a franking credit does or does not exist and, if such a purpose exists, that the purpose is or is not incidental to some other purpose." | Based on that construction of s177EA(3)(e) his Honour considered that, in the case of a capital raising where the issuer intended to frank distributions on an equity interest, there would be a purpose of enabling the holder of the interest to obtain franking credits. However, if the franking served no other purpose than to facilitate the capital raising, that would be an incidental purpose and s177EA would not apply. His Honour contrasted that with franking credit trading and franking credit streaming where it is the issue of equity interests that is incidental to the provision of franking credits. His Honour noted that there are other scenarios where the circumstances would be more nuanced. | His Honour, in considering the Commissioner's notice of contention, also disagreed with the Full Federal Court on the construction of s177EA(17)(ga) and whether s177D(b)(vi) was a relevant circumstance. His Honour observed that the language in s177EA(17)(ga) of distributions "sourced, directly or indirectly, from unrealised or untaxed profits" was not used elsewhere in the legislation and that the expression "unrealised or untaxed profits" was not further defined. His Honour considered that the language of s177EA(17)(ga) should be read in light of the list of categories of unfrankable distributions in s202-45 and its stated object "to ensure that only distributions equivalent to realised taxed profits can be franked". His Honour went on to say at [69] that: | "The word "profits" has no rigid meaning in income tax law . It is consistent with the object of s 177EA as a whole to treat s 177EA(17)(ga) as designed to capture distributions outside the listed categories of unfrankable distributions which were traceable to a source which had not borne income tax . The circumstance that distributions on the notes were to be paid by the New Zealand branch of the Bank without payment of Australian income tax by the Bank on the source of funding is therefore a relevant consideration within s 177EA(17)(ga)." | In respect of s177D(b)(vi), his Honour inferred that without PERLS v the Bank would have raised Tier 1 capital by other means at a higher cost and therefore agreed that there was a change in the financial position of the Bank by the issue of PERLS v as it constituted the raising of capital by the Bank at a cheaper cost. | His Honour observed that, similar to s177D(b), an individual analysis of each of the relevant circumstances in s177EA(17) was not required and that a global assessment of purpose was permissible as long as the factors were taken into account. In this regard, his Honour noted how the primary judge and the Full Court had dealt with the matter by painstaking analysis of the 18 circumstances listed in s177EA(17) which demonstrated that very few of those circumstances had a material bearing on the ultimate conclusion required to be drawn under s177EA(3)(e). | For the purposes of the present case, his Honour decided that the question posed by s177EA(3)(e) could be broken down into two sub-questions. In issuing PERLS V, did the Bank have a purpose of enabling holders to obtain franking credits? If so, was that purpose subordinate to or in subsidiary conjunction with some other purpose? | His Honour stated that the answer to both questions was "yes" and went on to say at [75 ]and [76] that: "The Bank obviously issued PERLS v with the intention of holders obtaining franking credits: the proposed franking of distributions was not only disclosed in the prospectus, it was integral to the calculation of the distribution on the notes (s 177EA(17)(f)), integral to the calculation of yield to investors (ss 177D(b)(ii) and 177D(b)(iv)) and integral to the calculation by the Bank of its after tax cost of capital (ss 177D(b)(ii), 177D(b)(iv) and 177D(b)(vi)). The Bank equally obviously issued PERLS v because the Bank needed to raise Tier 1 capital in circumstances where all the means available to the Bank to raise Tier 1 capital would have involved the Bank franking distributions to the same extent and where PERLS v represented the most commercially attractive of those available means (s 177D(b)(ii)). The circumstances that Tier 1 capital raised by the Bank from the issue of PERLS v was to be used by the Bank to generate income in New Zealand not taxable in Australia, and that distributions on the notes were deductible against assessable income in New Zealand, are required to be taken into account as relevant circumstances (ss 177EA(17)(ga), 177D(b)(ii) and 177D(b)(vi)). However, their probative value for the purpose of answering the question ultimately posed by s 177EA(3)(e) is elusive. They do not make it more or less likely that the Bank had a purpose of enabling the holders of PERLS v to obtain franking credits and they do nothing to alter the relationship between that purpose and its purpose of raising Tier 1 capital. "

Issues decided:
The issue before the High Court was whether, having regard to relevant circumstances, s177EA applied to deny imputation benefits attached to distributions to investors on the basis that the arrangement was entered into or carried out for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling investors to obtain the imputation benefits. The High Court unanimously allowed the taxpayers appeal with French CJ, Hayne, Kiefel and Bell JJ agreeing with the reasons of Justice Gageler. Justice Gageler noted two uncontroversial features of the "relevant circumstances" in s177EA(17). First, that the relevance of the relevant circumstances lies in the extent to which they are probative of the ultimate question as to purpose. Secondly, that while the circumstances referred to in s177EA(17) are not exhaustive, they are mandatory relevant considerations and, where they exist, must be taken into account. However, their degree of relevance will vary according to the extent to which they are probative of the ultimate question. His Honour identified two questions of construction of s177EA(3)(e) pivotal to the application of s177EA , namely, what amounts to a "purpose of enabling" and when is such a purpose "an incidental purpose". In considering when a purpose is an incidental purpose, his Honour quoted the statement in the Explanatory Memorandum for s177EA that "a purpose is an incidental purpose when it occurs fortuitously or in subordinate conjunction with another purpose, or merely follows another purpose as its natural incident". His Honour went on to say that a purpose would be an incidental purpose and outside the scope of s177EA(3)(e) "if that purpose does no more than further some other purpose or follow from some other purpose". His Honour said that in adopting that meaning of incidental purpose there was no warrant for further confining the application of s177EA by adopting a strained meaning of the word "enabling" in s177EA(3)(e) (as argued for by the appellant) and that it was best read in the sense suggested by the majority in the Full Federal Court as that of "supplying with the requisite means or opportunities to [that] end" However, his Honour disagreed with the majority of the Full Federal Court in relation to the construction of s177EA(3)(e) in two respects. At [66] his Honour stated that: "...a purpose can be incidental even where it is central to the design of a scheme if that design is directed to the achievement of another purpose. Indeed, the centrality of a purpose to the design of a scheme directed to the achievement of another purpose may be the very thing that gives it a quality of subsidiarity and therefore incidentality. That is not impermissibly to confine the scope of s177EA(3)(e) to a dominant purpose: the categories of "dominant" and "incidental" are not exhaustive. " and "...counterfactual analysis is not antithetical to the statutory inquiry mandated by s 177EA(3)(e). Purpose is a matter for inference and incidentality is a matter of degree. Consideration of possible alternatives may well assist the drawing of a conclusion in a particular case that a purpose of enabling a holder to obtain a franking credit does or does not exist and, if such a purpose exists, that the purpose is or is not incidental to some other purpose." and "...counterfactual analysis is not antithetical to the statutory inquiry mandated by s 177EA(3)(e). Purpose is a matter for inference and incidentality is a matter of degree. Consideration of possible alternatives may well assist the drawing of a conclusion in a particular case that a purpose of enabling a holder to obtain a franking credit does or does not exist and, if such a purpose exists, that the purpose is or is not incidental to some other purpose." Based on that construction of s177EA(3)(e) his Honour considered that, in the case of a capital raising where the issuer intended to frank distributions on an equity interest, there would be a purpose of enabling the holder of the interest to obtain franking credits. However, if the franking served no other purpose than to facilitate the capital raising, that would be an incidental purpose and s177EA would not apply. His Honour contrasted that with franking credit trading and franking credit streaming where it is the issue of equity interests that is incidental to the provision of franking credits. His Honour noted that there are other scenarios where the circumstances would be more nuanced. His Honour, in considering the Commissioner's notice of contention, also disagreed with the Full Federal Court on the construction of s177EA(17)(ga) and whether s177D(b)(vi) was a relevant circumstance. His Honour observed that the language in s177EA(17)(ga) of distributions "sourced, directly or indirectly, from unrealised or untaxed profits" was not used elsewhere in the legislation and that the expression "unrealised or untaxed profits" was not further defined. His Honour considered that the language of s177EA(17)(ga) should be read in light of the list of categories of unfrankable distributions in s202-45 and its stated object "to ensure that only distributions equivalent to realised taxed profits can be franked". His Honour went on to say at [69] that: "The word "profits" has no rigid meaning in income tax law . It is consistent with the object of s 177EA as a whole to treat s 177EA(17)(ga) as designed to capture distributions outside the listed categories of unfrankable distributions which were traceable to a source which had not borne income tax . The circumstance that distributions on the notes were to be paid by the New Zealand branch of the Bank without payment of Australian income tax by the Bank on the source of funding is therefore a relevant consideration within s 177EA(17)(ga)." In respect of s177D(b)(vi), his Honour inferred that without PERLS v the Bank would have raised Tier 1 capital by other means at a higher cost and therefore agreed that there was a change in the financial position of the Bank by the issue of PERLS v as it constituted the raising of capital by the Bank at a cheaper cost. His Honour observed that, similar to s177D(b), an individual analysis of each of the relevant circumstances in s177EA(17) was not required and that a global assessment of purpose was permissible as long as the factors were taken into account. In this regard, his Honour noted how the primary judge and the Full Court had dealt with the matter by painstaking analysis of the 18 circumstances listed in s177EA(17) which demonstrated that very few of those circumstances had a material bearing on the ultimate conclusion required to be drawn under s177EA(3)(e). For the purposes of the present case, his Honour decided that the question posed by s177EA(3)(e) could be broken down into two sub-questions. In issuing PERLS V, did the Bank have a purpose of enabling holders to obtain franking credits? If so, was that purpose subordinate to or in subsidiary conjunction with some other purpose? His Honour stated that the answer to both questions was "yes" and went on to say at [75 ]and [76] that: "The Bank obviously issued PERLS v with the intention of holders obtaining franking credits: the proposed franking of distributions was not only disclosed in the prospectus, it was integral to the calculation of the distribution on the notes (s 177EA(17)(f)), integral to the calculation of yield to investors (ss 177D(b)(ii) and 177D(b)(iv)) and integral to the calculation by the Bank of its after tax cost of capital (ss 177D(b)(ii), 177D(b)(iv) and 177D(b)(vi)). The Bank equally obviously issued PERLS v because the Bank needed to raise Tier 1 capital in circumstances where all the means available to the Bank to raise Tier 1 capital would have involved the Bank franking distributions to the same extent and where PERLS v represented the most commercially attractive of those available means (s 177D(b)(ii)). The circumstances that Tier 1 capital raised by the Bank from the issue of PERLS v was to be used by the Bank to generate income in New Zealand not taxable in Australia, and that distributions on the notes were deductible against assessable income in New Zealand, are required to be taken into account as relevant circumstances (ss 177EA(17)(ga), 177D(b)(ii) and 177D(b)(vi)). However, their probative value for the purpose of answering the question ultimately posed by s 177EA(3)(e) is elusive. They do not make it more or less likely that the Bank had a purpose of enabling the holders of PERLS v to obtain franking credits and they do nothing to alter the relationship between that purpose and its purpose of raising Tier 1 capital. "

ATO view of decision:
As indicated in previous Decision Impact Statements on Part IVA, the ATO will take all decisions of the High Court and Federal Court into account in applying Part IVA to the particular facts of cases. | In this case, the High Court found that the Bank had a demonstrated need to raise Tier 1 capital; that this was its main purpose; and that all means available to do so would have involved the Bank franking distributions to the same extent. The High Court held, therefore, that the franking purpose was no more than incidental in the sense that it furthered, or followed as a natural consequence of, the commercial requirement for Tier 1 capital and that the other identified relevant circumstances were not sufficiently probative of purpose to alter this conclusion. | If the same facts and circumstances subsist in other cases of Tier 1 capital-raising, it is clear that s177EA will not apply. | Incidental purpose | The High Court stated at [64] that, in the context of s177EA, a franking purpose will be incidental "if that purpose does no more than further some other purpose or follow from some other purpose" and at paragraph 66 that "a purpose can be incidental even where it is central to the design of a scheme if that design is directed to the achievement of another purpose". | The High Court did emphasise, however, that this does not "impermissibly confine the scope of s177EA(3)(e) to a dominant purpose: the categories of "dominant" and "incidental" are not exhaustive. " | The decision suggests that in cases where a substantial, albeit not dominant, purpose of franking is evident, there will be a need to carefully scrutinise the extent to which the franking purpose can be said to do no more than further, or follow from, some other purpose. | Relevant circumstances | The High Court has confirmed that the circumstances listed in s177EA(17) are not exhaustive of the matters that may be probative of the ultimate question as to purpose. Accordingly, it was stated at [66] that counterfactual analysis was not antithetical to the inquiry mandated by paragraph 177EA(3)(e), noting that purpose is a matter for inference and incidentality is a matter of degree. This type of analysis was held to be a relevant consideration, not only fitting within subparagraph 177D(b)(ii) in the circumstances of the case, but also because it was logically probative of the conclusion to be drawn under paragraph177EA(3)(e). | However, the Court did not go so far as to say that this was a mandatory consideration or that it operated in the same way as s177C to establish the existence of the relevant tax (imputation) benefit. Rather, the High Court said that consideration of possible alternatives may well assist the drawing of a conclusion in a particular case as to the existence of the relevant purpose of enabling a holder to obtain an imputation benefit and, if so, whether that purpose is incidental or not to some other purpose. | In light of the High Court's confirmation that the list of relevant circumstances in s177EA(17) is not exhaustive, it can also be contemplated that particular fact patterns in other types of cases may reveal other relevant considerations beyond the mandatory considerations in s177EA(17) that could have a bearing on the statutory question of purpose. | Other forms of capital raising | Whether s177EA applies in situations other than the particular circumstances of the Tier 1 capital-raising considered in this decision will depend on the facts and circumstances of each case. | At {67], the High Court compared a capital-raising where the intended franking does no more than facilitate the capital raising and is, therefore, an incidental purpose, with franking credit trading and franking credit streaming where it is the issue of equity interests that is incidental to the provision of franking credits. Between these ends of the spectrum, however, the High Court observed that "there are other scenarios within the "catch all" operation of s177EA where the circumstances are more nuanced." | No doubt in these other cases the probative value of some of the listed relevant circumstances would become less elusive. | In the absence of a consideration of all of the facts of a case, which is always necessary in determining the application of the general anti-avoidance rule, it is not possible for the ATO to indicate where on the spectrum various types of capital-raising will lie.

Administrative treatment:
Implications for ATO precedential documents (Public Rulings & Determinations etc) | TR2009/3 deals with arrangements that are somewhat different from the one considered in this decision. However, aspects of the Ruling will need to be considered, and possibly amended, to take into account the reasoning of the High Court.

Legislative references: Income Tax Assessment Act 1936 (Cth) 177D 177EA Income Tax Assessment Act 1997 (Cth) Pt 3-6 Div 974
Case references: Federal Commissioner of Taxation v Spotless Services Ltd (1996) 186 CLR 404 [1996] HCA 34 34 ATR 183 96 ATC 5201 Federal Commissioner of Taxation v Sun Alliance Investments Pty Ltd (2005) 225 CLR 488 [2005] HCA 70 60 ATR 560 2005 ATC 4955 Federal Commissioner of Taxation v Hart (2004) 217 CLR 216 [2004] HCA 26 55 ATR 712 2004 ATC 4599 Federal Commissioner of Taxation v Consolidated Press Holdings Ltd (2001) 207 CLR 235 [2001] HCA 32 47 ATR 229 2001 ATC 4343