Commissioner of Taxation v Visy Industries USA Pty Ltd
Document type: Decision Impact Statement
Venue: Federal Court of Australia (VID 1124 of 2011; VID 1125 of 2011)
Judgment date: 10 August 2012
Date published: 18 January 2013

Summary of decision:
Outlines the ATO's reponse to this case which concerned whether the taxpayer could claim a deduction for an indemnity fee paid to a related party in relation to a contract which the ATO submitted was not commercial or made with a view to profit.

Overview of facts:
The taxpayer was a member of the Pratt Group of companies whose business included waste collection, paper and cardboard manufacture, primary packaging and property and share investments. The taxpayer was the Australian holding company of the Pratt Group's overseas manufacturing division which operated in the United States. | The matter concerned whether an indemnity fee of $27.05 million paid by the taxpayer to a Pratt Group company was an allowable deduction in the 1999 income year under s 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997). The fee was for the taxpayer to be indemnified against any losses that it might incur under a foreign currency internal hedging arrangement with Pratt Finance Pty Ltd, another Pratt Group company. | In 1997 Pratt Finance borrowed USD $400 million from a syndicate of 18 US financial institutions by issuing bonds with maturity dates ranging from 15 to 20 years. Pratt Finance entered into external hedges to cover its foregin exchange risk as to USD $200 million and an internal hedge (the forward exchange contract) to cover the risk on the remaining USD $200 million of borrowings. The internal hedge, for which the taxpayer was not paid a fee [40], required it to deliver USD currency to Pratt Finance on dates in 2015, 2016 and 2017 at an exchange rate of 0.775. As the taxpayer was the holding company of Pratt group subsidiaries that conducted the operations in the US and held US dollar denominated assets, the internal hedge was said to equate to a 'natural hedge' against adverse movements in the USD/AUD exchange rate. | By the middle of 1998, the Australian dollar had fallen against the US dollar and the taxpayer, as a result of the forward exchange contract, had an unrealised loss of AUD 80 million. This raised issues about the ability of the taxpayer to meet the liability if it was called on to do so. The taxpayer did not have direct access to US dollars and the only way it could meet its liability would be to raise US debt itself or sell some of its US assets. At about the same time, the external auditors questioned the effectiveness of the forward exchange contract as an internal hedge. The internal hedge was important to Pratt Finance's ability to satisfy its borrowing covenants and avoid accounting exposures. | By April 1999, the AUD had reached 0.645 and it was agreed that to mitigate its exposure under the internal hedge the taxpayer should enter into an agreement (the forward agreement) with a related counterparty. This occurred and in June 1999 the taxpayer paid the equivalent of A$27.05 million (the indemnity fee) to its wholly owned subsidiary company to be indemnified against any losses that it might incur under the internal hedge with Pratt Finance. | Although there was no contemporaneous evidence of how the taxpayer could realise profit before maturity of the hedged borrowings between 2015 and 2017, at first instance the Federal Court accepted oral evidence from senior Visy/Pratt executives that the taxpayer could enter into some form of derivative transaction and that this could occur without compromising the internal hedge arrangements. | The Federal Court held that the indemnity fee was deductible as being incurred in gaining or producing assessable income, or as being incurred in carrying on a business for that purpose, and that it was not an outgoing of capital or of a capital nature. | Issues decided by the Full Federal Court | The Commissioner pressed 12 grounds in relation to the appeal from the Federal Court, which mainly challenged the conclusions that the Court drew from the findings of primary fact. | The grounds included that: • the deduction was not allowable under s 8-1 as the requisite profit making purpose was not established, • that the gross amount which might be received under the hedging arrangement after 18 years could not in itself be said to be a recognised category of income until any profit outcome is known, • that receipts and outgoings accounting does not give a correct reflex of the outcome of the profit making undertaking (the Court described this as the 'tax accounting ground') and • that the payment of the indemnity fee was an outgoing of capital. | • the deduction was not allowable under s 8-1 as the requisite profit making purpose was not established, • that the gross amount which might be received under the hedging arrangement after 18 years could not in itself be said to be a recognised category of income until any profit outcome is known, • that receipts and outgoings accounting does not give a correct reflex of the outcome of the profit making undertaking (the Court described this as the 'tax accounting ground') and • that the payment of the indemnity fee was an outgoing of capital. | The Full Federal Court rejected the Commissioner's challenge to specific findings of secondary fact that underpinned the Federal Court's conclusion that Visy USA entered into the Forward Exchange Contract with a not insignificant purpose of profit-making (Visy at [53]- [55]). The Full Court found no error in the Federal Court's finding that a business activity may be carried on notwithstanding that the activity may be dependent, in part, on chance (Visy at [58]): No error was found in the primary judge's treatment of the indemnity fee as: "substituted expenditure", relying on W Nevill & Co Ltd v FCT (1937) 56 CLR 290 at 307, per Dixon, J. (Visy at [61])-[63]); or a payment that was similar to insurance, having regard to Australian National Hotels v FCT (1988) 19 FCR 234 (Visy at [64]-[70) and, in the Court's view more aptly, to WD & HO Wills (Aust) Pty Ltd v FCT (1996) 65 FCR 298. | The Full Court stated that: '...in the present case neither the size of the Indemnity Fee nor the fact that the insurer was related to Visy USA furthers a conclusion that it was an outgoing of a capital nature.' The Full Court noted that although the related party agreements may have been outside the ordinary course of its business, they were entered into for the purpose of profit-making. Accordingly, they have the same revenue consequences as a transaction entered into by the taxpayer in the ordinary course of its business. In addition, at [75], their Honours said that the taxpayer wished to protect itself from the possibility that it may incur foreign exchange losses and this was an advantage or benefit sought from a 'practical and business point of view'. | The Full Court's conclusions in these respects were, primarily, founded on the pivotal passage in Commissioner of Taxation v Myer Emporium Ltd (1986-1987) 163 CLR 199 at 209-210. In that passage, the High Court distinguished profits or gains made in the ordinary course of business and profits or gains from transactions entered into outside the ordinary course of a taxpayer's business. In the latter case, the character of the profit or gain generally depends on the taxpayer's intention or purpose (Visy at [52]). The requisite purpose had been found to be present in this case. | That the payment of the indemnity fee may have enabled Visy USA or the Pratt Group to avoid bringing to account or disclosing the unrealised loss under the Forward Exchange Contract did not re-characterise as capital a revenue outgoing incurred in the course of the taxpayer's business, albeit not in the ordinary course (Visy at [75]-[76]). | Further, as to Nevill, the Full Court expressed the view, in obiter dicta, that there is nothing in its reasoning that would confine the "substituted expenditure" principle to expenditure incurred in carrying on a business (Visy at [63]). | Finally, the Full Court held that the 'tax accounting ground' (Visy at [80]) was misconceived as: (a) the indemnity payment was incurred in the course of the taxpayer's business, even though outside its ordinary course. In such a case, FCT v Montgomery (1999) 198 CLR 639 at [111] contemplated that it was gross receipts not the net profit of an adventure that were to be characterised as revenue receipts (Visy at [83]); and (b) more fundamentally, if an amount is otherwise income derived, or a deduction allowed, in a given year, then derivation or deductibility is not deferred until a later year when a profit can be determined by reference to some wider transaction of which (relevantly) the outgoing forms a part (Visy at [84]). | (a) the indemnity payment was incurred in the course of the taxpayer's business, even though outside its ordinary course. In such a case, FCT v Montgomery (1999) 198 CLR 639 at [111] contemplated that it was gross receipts not the net profit of an adventure that were to be characterised as revenue receipts (Visy at [83]); and (b) more fundamentally, if an amount is otherwise income derived, or a deduction allowed, in a given year, then derivation or deductibility is not deferred until a later year when a profit can be determined by reference to some wider transaction of which (relevantly) the outgoing forms a part (Visy at [84]).

Issues decided:
The Commissioner pressed 12 grounds in relation to the appeal from the Federal Court, which mainly challenged the conclusions that the Court drew from the findings of primary fact. The grounds included that: • the deduction was not allowable under s 8-1 as the requisite profit making purpose was not established, • that the gross amount which might be received under the hedging arrangement after 18 years could not in itself be said to be a recognised category of income until any profit outcome is known, • that receipts and outgoings accounting does not give a correct reflex of the outcome of the profit making undertaking (the Court described this as the 'tax accounting ground') and • that the payment of the indemnity fee was an outgoing of capital. • the deduction was not allowable under s 8-1 as the requisite profit making purpose was not established, • that the gross amount which might be received under the hedging arrangement after 18 years could not in itself be said to be a recognised category of income until any profit outcome is known, • that receipts and outgoings accounting does not give a correct reflex of the outcome of the profit making undertaking (the Court described this as the 'tax accounting ground') and • that the payment of the indemnity fee was an outgoing of capital. The Full Federal Court rejected the Commissioner's challenge to specific findings of secondary fact that underpinned the Federal Court's conclusion that Visy USA entered into the Forward Exchange Contract with a not insignificant purpose of profit-making (Visy at [53]- [55]). The Full Court found no error in the Federal Court's finding that a business activity may be carried on notwithstanding that the activity may be dependent, in part, on chance (Visy at [58]): No error was found in the primary judge's treatment of the indemnity fee as: "substituted expenditure", relying on W Nevill & Co Ltd v FCT (1937) 56 CLR 290 at 307, per Dixon, J. (Visy at [61])-[63]); or a payment that was similar to insurance, having regard to Australian National Hotels v FCT (1988) 19 FCR 234 (Visy at [64]-[70) and, in the Court's view more aptly, to WD & HO Wills (Aust) Pty Ltd v FCT (1996) 65 FCR 298. The Full Court stated that: '...in the present case neither the size of the Indemnity Fee nor the fact that the insurer was related to Visy USA furthers a conclusion that it was an outgoing of a capital nature.' The Full Court noted that although the related party agreements may have been outside the ordinary course of its business, they were entered into for the purpose of profit-making. Accordingly, they have the same revenue consequences as a transaction entered into by the taxpayer in the ordinary course of its business. In addition, at [75], their Honours said that the taxpayer wished to protect itself from the possibility that it may incur foreign exchange losses and this was an advantage or benefit sought from a 'practical and business point of view'. The Full Court's conclusions in these respects were, primarily, founded on the pivotal passage in Commissioner of Taxation v Myer Emporium Ltd (1986-1987) 163 CLR 199 at 209-210. In that passage, the High Court distinguished profits or gains made in the ordinary course of business and profits or gains from transactions entered into outside the ordinary course of a taxpayer's business. In the latter case, the character of the profit or gain generally depends on the taxpayer's intention or purpose (Visy at [52]). The requisite purpose had been found to be present in this case. That the payment of the indemnity fee may have enabled Visy USA or the Pratt Group to avoid bringing to account or disclosing the unrealised loss under the Forward Exchange Contract did not re-characterise as capital a revenue outgoing incurred in the course of the taxpayer's business, albeit not in the ordinary course (Visy at [75]-[76]). Further, as to Nevill, the Full Court expressed the view, in obiter dicta, that there is nothing in its reasoning that would confine the "substituted expenditure" principle to expenditure incurred in carrying on a business (Visy at [63]). Finally, the Full Court held that the 'tax accounting ground' (Visy at [80]) was misconceived as: (a) the indemnity payment was incurred in the course of the taxpayer's business, even though outside its ordinary course. In such a case, FCT v Montgomery (1999) 198 CLR 639 at [111] contemplated that it was gross receipts not the net profit of an adventure that were to be characterised as revenue receipts (Visy at [83]); and (b) more fundamentally, if an amount is otherwise income derived, or a deduction allowed, in a given year, then derivation or deductibility is not deferred until a later year when a profit can be determined by reference to some wider transaction of which (relevantly) the outgoing forms a part (Visy at [84]). (a) the indemnity payment was incurred in the course of the taxpayer's business, even though outside its ordinary course. In such a case, FCT v Montgomery (1999) 198 CLR 639 at [111] contemplated that it was gross receipts not the net profit of an adventure that were to be characterised as revenue receipts (Visy at [83]); and (b) more fundamentally, if an amount is otherwise income derived, or a deduction allowed, in a given year, then derivation or deductibility is not deferred until a later year when a profit can be determined by reference to some wider transaction of which (relevantly) the outgoing forms a part (Visy at [84]).

ATO view of decision:
The ATO accepts that once it was concluded that the taxpayer's entry into the Forward Exchange Contract was within the scope of its business (though not the ordinary course of its business), it was open to conclude that the not insignificant purpose of profit making attributed to the Forward Exchange Contract led to the same taxation consequences as a transaction entered into by a taxpayer in the ordinary course of its business [67]. If a loss was incurred under the Forward Exchange Contract it would be deductible under s.8-1(1)(b), assuming it was not on capital account. With that established, it was open to the Court to conclude that the Forward Agreement should carry the same revenue consequences as the Forward Exchange Contract [67]. | The ATO respectfully accepts that the various statements of legal principle in the decision are correct.

Administrative treatment:
Nil | Implications for ATO precedential documents (Public Rulings & Determinations etc) | Nil

Legislative references: Income Tax Assessment Act 1997 6-5 8-1 Evidence Act 1995 (Cth) 191 Taxation Administration Act 1953
Case references: Commissioner of Taxation v Myer Emporium Ltd (1986-1987) 163 CLR 199 18 ATR 693 87 ATC 4363 [1987] HCA 18 W Nevill & Co Ltd v Federal Commissioner of Taxation (1937) 56 CLR 290 [1937] HCA 9 GP International Pipecoaters Pty Ltd v Federal Commissioner of Taxation (1990) 170 CLR 124 21 ATR 1 90 ATC 4413 [1990] HCA 25 Federal Commissioner of Taxation v Citylink Melbourne Limited (2006) 228 CLR 1 [2006] HCA 35 62 ATR 648 2006 ATC 4404 Australian National Hotels v Federal Commissioner of Taxation (1988) 19 FCR 234 19 ATR 1575 88 ATC 4627
Subject references: Deductibility of indemnity fee Forward exchange contract Internal hedge Isolated transaction