32 ATR 309; 133 ALR 165; 95 ATC 4,775; 1995 WL 1691089; 70 ALJ 186; 31 Taxation in Aust 368; 48 Australian Company Secretary 159; [1995] CCH Tax Week 1,001; 7 CCH J of Aust Taxn (No 6) 2

Commissioner of Taxation v Spotless Services Ltd and Another

An application for special leave to appeal to the High Court was granted on 16

April 1996.

Northrop , Beaumont and Cooper JJ

General Division: Victoria District Registry

17 March 1995, 27 November 1995

Income Tax - Interest - On money lent in Cook Islands - Indicia determining source of interest - Contract constituted by offer received in Australia and accepted by conduct in Cook Islands - Securities banker's letter of credit and certificate of deposit - Letter of credit received in Australia and certificate of deposit received in Cook Islands - Rights under letter of credit dependent on issue of certificate of deposit - Whether income sourced from Cook Islands - Whether exempt income under Income Tax Assessment Act 1936 (Cth), s 23(q)

Income Tax - Tax avoidance - Income Tax Assessment Act 1936 (Cth), Pt IVA scheme - Scheme to be identified with factual specificity - Lending off shore - Dominant purpose to maximise income - Whether tax benefit obtained - Whether scheme to which Pt IVA, ss 177A applied - Income Tax Assessment Act 1936 (Cth), Pt IVA, ss 177A, 177C, 177D, 177F

Scheme - Tax benefit - Amount - Income Tax Assessment Act 1936 (Cth), Pt IVA, ss 177A, 177C, 177D

In Australia there was promoted a scheme for depositing money with a company (BCL) a wholly-owned subsidiary of another (BC) both incorporated in the Cook Islands and the payment of interest subject to Cook Island's modest withholding tax. Between Australia and the Cook Islands no tax treaty existed. The securities were to be a certificate of deposit issued by BCL and a letter of credit issued by Midland Bank plc (Midland). The scheme was expressly contrived to produce exempt income within s 23(q) to be sourced from the Cook Islands. Its promoters described it as investment in the certificate of deposit.

The respondents were Australian residents. Terms for deposits by the respondents with BCL were negotiated in the Cook Islands. By telex from the Cook Islands to the respondents in Melbourne, an offer was made to them which was available for acceptance by them by delivery of a cheque drawn in favour of BCL at the offices of BC in the Cook Islands.

Afterwards, in Melbourne, one of the respondents (the respondent), for it and the other respondent, gave to or for Midland a cheque for the deposit (the money). The respondent received Midland's irrevocable banker's letter of credit. It was a precondition of the entitlement of the respondent to call on the letter of credit that there issue a certificate of deposit. Midland was authorised to apply the money to an account of the respondent in the Cook Islands. The respondent's attorney, especially appointed to implement the scheme, was authorised to open an account with BC in the Cook Islands.*245

Afterwards, in the Cook Islands, the respondent by its attorney drew a cheque on BC in favour of BCL or order (the cheque) which was handed to BCL. BCL gave to the respondent's attorney a certificate of deposit.

The respondent did not have an account with BC in the Cook Islands. On the evidence, the money was credited to BC's account with Midland's Singapore branch to be disbursed as directed by BC, and no money was credited to any account of the respondent with BCL.

The money was repaid with interest less withholding tax from the Cook Islands.

A. At the relevant times, s 23(q) of the Income Tax Assessment Act 1936 (Cth) (the Act) provided, relevantly, that income derived by a resident from sources out of Australia was exempt income where it was not exempt from income tax in the country where the income was derived provided that there was a liability for tax in the country where that income was derived and the Commissioner was satisfied that the tax had been paid.

The Commissioner contended that the interest was sourced from within Australia and that s 23(q) did not apply. In holding that the interest was exempt income within s 23(q), the judge held the contract was constituted by the telexed offer which was accepted by the conduct in the Cook Islands.

Held: (1) By Cooper J, Northrop J agreeing. As between the respondent and BCL, the cheque operated as the equivalent of cash. The effect of the receipt of the cheque was to credit the respondent with the money on deposit in accordance with the certificate of deposit. The cheque operated as payment of money and the risk of non-payment on presentation of the cheque drawn on BC was borne by BCL. (275D)

National Australia Bank Ltd v KDS Construction Services Pty Ltd (1987) 163 CLR 668 at 676-677; Barclays Bank Ltd v Astley Industrial Trust Ltd [1970] 2 QB 527 at 539, applied.

(2) By the Court. The interest was sourced from the Cook Islands and was exempt income within s 23(q). (262F, 276D)

Per Beaumont J. So held from a practical business standpoint. (262F)

Per Cooper J, Northrop J agreeing. So held after considering the facts as matters of practical substance. (276C)

B. Under Pt IVA of the Act, where (i) there was a scheme (s 177A), (ii) in connection with that scheme a taxpayer obtained a tax benefit, namely, an amount was not included in the assessable income of the taxpayer which might reasonably be expected to have been included in the taxpayer's assessable income if the scheme had not been undertaken (s 177C), and (iii) having regard to the matters specified in s 177D(b) it would be concluded that a person who carried out all or part of the scheme did so for the dominant purpose of enabling the taxpayer to obtain a tax benefit, then (iv) the Commissioner could under s 177F make a determination to include the tax benefit amount in the assessable income of the taxpayer.

The Commissioner alternatively determined under s 177F(1)(a) if the interest was exempt income within s 23(q) that it was a tax benefit within s 177C.

Held, by Cooper J, Northrop J agreeing: (1) The definition of scheme in s 177A requires that the parties to the scheme, in so far as they are known, must be identified and the terms or content of any agreement, arrangement, understanding, promise or undertaking and the steps or stages of any course of action or proposal, in so far as they are relevant, be identified. It is not sufficient to identify a scheme by reference to a hoped-for fiscal outcome. Section 177A requires that the scheme has an existence based in fact and reality and is not something based on the Commissioner's view of the facts or their legal effect. (279F-G)

(2) What are or are not objectively usual commercial considerations fall to be determined under s 177D(b) and not under s 177A or in a vacuum divorced from facts as found. (280B)

(3) There was a scheme within s 177A, it being the proposal to invest the money *246 on deposit in the Cook Islands and to pay Cook Islands withholding tax on the interest earned, and the taking of all necessary steps to implement the proposal. (280E, 284E)

(4) In order to satisfy the test under s 177C what has to be ignored is not the tax consequence of s 23(q) on the derivation of interest which would otherwise be assessable as income under s 25 of the Act, but the scheme as identified. If that means that the interest would not have been earned then it is necessary to identify reasonable expectations as to what would in fact have occurred and not mere possibilities. What would have been derived must be assessable income. (282F)

Commissioner of Taxation (Cth) v Peabody (1994) 181 CLR 359 at 385, applied.

(5) The respondents received a tax benefit within s 177C in an amount equal to the interest less Cook Islands withholding tax which they received from the Cook Islands investments. (285B)

(6) The matters to which regard is directed under s 177D(b) are to be determined objectively having regard to the particular circumstances of the taxpayers, as is the ascertainment of the purpose of the person or one of the persons who entered into the scheme. (286B)

(7) The dominant purpose of the respondents was to obtain the maximum return on the money invested after the payment of all applicable costs, including tax and was not to obtain a tax benefit within s 177D. Accordingly, the scheme was not one to which Pt IVA of the Act applied. (288E)

Appeal against the decision of Lockhart J reported at (1993) 25 ATR 344, dismissed.

Cases Cited

The following cases are cited in the judgments:

Barclays Bank Ltd v Astley Industrial Trust Ltd [1970] 2 QB 527.

Esquire Nominees as Trustee of Manolas Trust v Commissioner of Taxation (Cth) (1972) 129 CLR 177.

Inland Revenue, Commissioner of (NZ) v NV Philips Gloeilampenfabrieken (1954) 10 ATD 435.

Nathan v Commissioner of Taxation (Cth) (1918) 25 CLR 183.

National Australia Bank Ltd v KDS Construction Services Pty Ltd (1987) 163 CLR 668.

Peabody v Commissioner of Taxation (1993) 40 FCR 531.

Spotless Services Ltd v Commissioner of Taxation (Cth) (1993) 25 ATR 344.

Tariff Reinsurances Ltd v Commissioner of Taxes (Vic) (1938) 59 CLR 194.

Taxation, Commissioner of v Jackson (1990) 27 FCR 1.

Taxation, Commissioner of (Cth) v Peabody (1994) 181 CLR 359.

Taxation, Commissioner of (Cth) v United Aircraft Corporation (1943) 68 CLR 525.

Thorpe Nominees Pty Ltd v Commissioner of Taxation (Cth) (1988) 19 ATR 1,834.

Appeal

B J Shaw QC and G T Pagone, for the appellant.

J McL Emmerson QC and J W de Wijn, for the respondents.

Cur adv vult

27 November 1995

Northrop J.

I would dismiss each appeal with costs. I concur with the reasons expressed by Cooper J.*247

Beaumont J.

Introduction

These are appeals from orders made by a judge of the Court (Lockhart J) allowing appeals by two related taxpayers, Spotless Services Limited (Spotless Services) and Spotless Finance Pty Ltd (Spotless Finance), the present respondents, from decisions of the Commissioner of Taxation disallowing objections by the respondents against assessments of income tax in the 1987 year of income. (His Honour's decision is now reported: see Spotless Services Ltd v Commissioner of Taxation (Cth) (1993) 25 ATR 344.)

The return of income of each respondent disclosed the receipt of interest, in the amounts of $2,670,663 and $295,688 respectively, derived from the deposit of funds ($36 million and $4 million respectively) in the Cook Islands with European Pacific Banking Company Limited (EPBCL), a Cook Islands corporation. However, the respondents claimed that the interest was exempt from income tax by virtue of s 23(q) of the Income Tax Assessment Act 1936 (Cth) (the Act) which was then in force. (By s 23(q), as it then stood, it was provided, relevantly, that income derived by a resident from sources out of Australia was exempt income where it was not exempt from income tax in the country where the income was derived provided that there was a liability for tax in the country where that income was derived and the Commissioner was satisfied that the tax had been, or would be, paid.) The respondents said that the interest had been derived from a source outside Australia, namely, in the Cook Islands; that in the case of Spotless Services, interest in the sum of $2,670,663 had been paid by EPBCL, but withholding tax of $103,230 had been paid on that interest in the Cook Islands; and that in the case of Spotless Finance, it had received $295,688 by way of interest from EPBCL in the Cook Islands, but withholding tax of $11,409 had been paid on that amount there. On the other hand, in his assessments, the Commissioner asserted that the interest had been derived from a source within Australia, so that s 23(q) could not apply.

Alternatively, the Commissioner assessed the respondents upon the basis that if, contrary to his contention, the source of the interest was located in the Cook Islands, the provisions of Pt IVA of the Act, dealing with schemes to reduce income tax, applied. The Commissioner made a determination pursuant to s 177F(1)(a) of the Act, asserting that the respondents had obtained a tax benefit in connection with a Pt IVA scheme, namely that the amount in question was an amount which would have been included or might reasonably be expected to have been included in the respondents' assessable income if the scheme had not been carried out. Lockhart J rejected each basis of assessment.

The primary facts and background

There is no dispute about the primary facts or the background to the litigation, which were as follows:

Consideration by the respondents of possible avenues of investment of $40m

In September 1986, Spotless Services received a substantial injection of funds in response to a public float of its shares. As a result, the Spotless Group then had about $40 million of funds available to it which were surplus to its requirements for the year ended 30 June 1987. A number of possible avenues of investment of the funds were considered at the time, including the EPBCL proposal that was adopted. Other alternatives then considered included a similar *248 kind of investment to be made in Hong Kong; this proposal, suggested by a merchant banking firm, involved a tax clearance being granted by the Commissioner. After discussions with the respondent's legal advisers, it was decided not to proceed. Another Cook Islands proposal, introduced by an overseas bank and involving another financial institution in the Cook Islands, was considered but rejected.

Discussion with Bankers Trust and the provision of EPBCL's "Information Memorandum"

The subject transactions arose out of discussions in Sydney in late 1986 between the executives of the respondents and representatives of the merchant banking firm Bankers Trust. In the course of those discussions, the respondents were provided with a pamphlet, published by EPBCL's parent, European Pacific Banking Corporation (EPBC), entitled "Information Memorandum relating to the Issue of Certificates of Deposit". The pamphlet stated, under the heading "Issue Details", the following:

"ISSUE DETAILS

DEPOSIT European Pacific Banking Company Limited a 100 per cent owned

TAKER: subsidiary of European Pacific Banking Corporation, incorporated

in the Cook Islands.

SECURITY: Certificates of Deposit supported by Letters of Credit issued by

Midland Bank PLC, Singapore Branch.

MINIMUM AUD 10 Million.

DEPOSITS:

TERMS: 90, 180, or 360 days, however longer terms are negotiable.

INTEREST The rate will be quoted reflecting market conditions at a margin

RATE: under the Bank Bill Rate for the term of the investment. All

interest will be subject to 5.0 per cent Cook Islands

withholding tax on the interest amount.

INTEREST All interest will be paid on a discounted basis on issue date.

PROFILE:

PURPOSE OF To expand the bank's deposit base. In all circumstances funds

ISSUE: raised by the issue of these Certificates of Deposit will be

applied to the bank's activities outside Australia. [Emphasis

added.]"

Under the heading "Nature of Investment", the following was stated:

"Nature of Investment

The interest on this investment is subject to withholding tax at its source in the Cook Islands and as no international tax treaty exists between the Cook Islands and Australia, the interest derived from the deposit should be exempt income for tax purposes in accordance with Section 23(q) of the Income Tax Assessment Act.

Attached as Appendix A, is a legal opinion from Stephen Jaques Stone James confirming that investment in the Certificates of Deposit by Australian residents produces exempt income. However, the advice in this opinion has been provided for the benefit of European Pacific Banking *249 Corporation only and intending investors should seek independent legal advice upon their own particular circumstances."

The legal opinion of Stephen Jaques Stone James (Stephens) annexed was in the form of a letter from that firm's Sydney office dated 2 September 1986 addressed to EPBC and entitled "Deposit of Funds in the Cook Islands". In the letter, it was stated that EPBC had requested Stephens "to advise [it] on the taxation consequences of a proposed transaction involving the Cook Islands". Stephens said that they understood that it was "intended that an Australian resident corporation should arrange for funds to be placed on deposit with [EPBCL] in the Cook Islands ...".

The letter went on to state the following by way of "Background":

"Background

We understand that the following series of transactions will take place.

1. An Australian resident investor will be approached by EPBCL from the Cook Islands to suggest the placement of a deposit with EPBCL.

2. The investor will open an account with Midland Bank plc in Singapore and another account with EPBC in the Cook Islands.

3. The investor will appoint an attorney in the Cook Islands with power to draw funds or cheques upon the investor's account with EPBC in the Cook Islands.

------

History

(Showing 2 of 3 documents)

Direct History

Commissioner of Taxation v Spotless Services Ltd and Another, 1995 WL 1691089, 133 ALR 165, 95 ATC 4775, 32 ATR 309, 62 FCR 244 (FCA Nov 27, 1995)

Reversed by

Commissioner of Taxation (Cth) v Spotless Services Ltd, 1996 WL 33102483, 186 CLR 404, 141 ALR 92, 71 ALJR 81, 96 ATC 5201, 34 ATR 183 (HCA Dec 03, 1996)

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