St George Bank Ltd v Commissioner of Taxation [2009] HCATrans 286 (3 November 2009)

Last Updated: 6 November 2009

[2009] HCATrans 286

IN THE HIGH COURT OF AUSTRALIA

Office of the Registry
Sydney No S139 of 2009
No S140 of 2009
No S141 of 2009
No S142 of 2009
No S143 of 2009

B e t w e e n -

ST GEORGE BANK LTD

ACN 055 513 070

Applicant

and

COMMISSIONER OF TAXATION

Respondent

Applications for special leave to appeal

FRENCH CJ
HEYDON J

TRANSCRIPT OF PROCEEDINGS

AT SYDNEY ON TUESDAY, 3 NOVEMBER 2009, AT 10.39 AM

Copyright in the High Court of Australia

MR B.W. WALKER, SC: May it please the Court, I appear with my learned friends, MS J.R.J. LOCKHART, SC and MS M. RICHMOND, SC, for the applicant. (instructed by Gilbert + Tobin)

MR T.P. MURPHY, SC: May it please the Court, I appear with my learned friend, MR J.O. HMELNITSKY, for the respondent. (instructed by Australian Government Solicitor)

FRENCH CJ: Yes, Mr Walker.

MR WALKER: Your Honours, the manner of decision, that is, the reasons given for the conclusions which determined the outcome for all four judges below, raises a matter, we submit, of transcended importance and of continuing application, even in the context of a great deal of borrowing transactions, contrary to what is put against us in writing by the respondent. To deal with the continued currency of these important issues first rendering it apt for special leave we have pointed out in paragraph 9 of our written reply, to which I will not take you in detail, commencing at application book 151, the manner in which, even for borrowings, these matters remain extant.

Could I therefore immediately go to the way in which we say the decision below, the way it proceeded, the steps in the reasoning and those matters which appear to have been decisive, render this a decision which this Court should take by way of a grant of special leave because, we submit, of the error which is shown and an error which is shown notwithstanding it is self-declared to be an application of principles well established, for example, relatively recently in Steele’s Case in this Court.

At application book page 114 is the culmination, in paragraph 105 of the reasoning of everything that precedes, but particularly the last couple of pages. In paragraph 105 the strands are identified and, in fact, drawn together. We would emphasise, in terms of the transcended importance beyond the particular facts of this banking transaction, the following matters to be found from that culminating paragraph. These are payments of interest. There is no doubt about that. As your Honours appreciate, that renders them a prime candidate, of course, to be deductible. Now, a payment of interest for a borrowing which, on any view of it – see lines 30, 31 on that page – was for funds which were to be used in the ordinary course of its business. I need hardly emphasise that the business of my client was, of course, the making of money by the laying out of money.

So we have here the two components that would ordinarily, lay down misère style, provide for deductibility. Matters of authority and, one may say, authoritative commentary in the person of Professor Parsons would suggest that the exceptional cases which would remove such a pairing of factors from driving and compelling a finding of deductibility will be found in cases such as payments of interest or rent above market and will particularly be given a badge against deductibility where there is a lack of arms-length dealing.

There is no more general proposition which, in particular, challenges in the authorities we drew to attention, which Justice Perram has not considered, nothing in what Professor Parsons has written on the matter, to which we have drawn attention in our written submission – see in particular our observation at application book 137, paragraph 26 – there is nothing in any of that material or in the previous authorities of this Court to suggest any entrenchment on the principle, one might say the fundamental or elementary proposition about deductibility of interest, that Steele’s Case in particular stands for.

Going back then to paragraph 105. How was that apparently compelling result avoided and, in fact, the opposite occurred? We submit that there is a resort to metaphor – structural advantage, line 21, conduit, line 22 – in the course of referring to an overall transaction, lines 20, 21, which, in our submission, deflects in a way which is contrary to principle of the inquiry which is necessary to determine deductibility. I stress, this was interest necessary, as we have shown, both to secure and maintain a borrowing of funds which themselves were laid out for the earning of income.

The overall transaction, of course, included a number of matters, but an overall transaction, in the absence of any Part IVA argument and in the absence of any allegation of sham, does not defeat the necessity, indeed, the requirement in all cases legally to characterise the transactions as they appear, and there was no doubt or contest about that in this case, once Part IVA fell away. The overall transaction may include, of course, multi-parties. A paradigm would be the acquisition of land by an agriculturalist who has the need to borrow funds in order to buy the capital asset of the land, who may be mortgaging it to another person to secure obligations of another kind, who may be engaged in relations with guarantors and who may have on-supply contracts to supermarkets and the like.

There will be an overall transaction, none of which will defeat the proposition that a structural advantage would be gained by that farmer in obtaining the further 10,000 acres necessary to supply Woolworths’ lettuce requirements. That is a structural advantage, to use yet another metaphor, the likes of which, in our submission, make this a fit case for a grant of special leave. What is the purpose of language like “structural advantage”, in our submission, when considering the question of deductibility of interest accepted on all hands to be paid for securing and maintaining a borrowing of funds, themselves a capital asset, used to derive returnable income?

The next step in Justice Perram’s reasoning shown in paragraph 105, having referred to a conduit, he is, at about line 28 or thereabouts, referring to the essentiality of the payments by reference to the regulatory requirements, but the essentiality of interest payments may be put in a far more commercial and direct form. If you do not pay the interest, you will be required, perhaps, to repay the principal prematurely, which was the case in this case, as we have set out in the uncontested factual position. The fact that there is a regulatory requirement either to have extra land if planning requires that for an agriculturalist who was irrigating, for example, or a bank to have extra forms of capital, in this case, adds nothing to the analysis whether or not the interest payment – the interest payment, which is the one whose deductibility is in question – is on capital or revenue account.

Steele’s Case, in our submission, though not mentioned here – of course his Honour does pay appropriate regard to it elsewhere in the reasons – is the constant presence when reading paragraph 105 because it makes it clear, and not for the first time, of course, that the fact that interest is paid for a borrowing where the borrowed funds themselves are either a capital asset or are used to acquire a capital asset is neither here nor there, has no dispositive quality whatever in characterising the payment of interest.

The reasoning in paragraph 105, with respect, threatens the clarity and simplicity of the propositions which in this country’s tax law would make it plain that when a farmer goes to a bank and borrows for 25 years $5 million to buy 10,000 acres, the fact that the 10,000 acres are themselves capital has nothing to the point if they are to be used to try and grow lettuces, then the interest for that 25-year loan will, of course, be deductible, not on capital account.

The structural advantage that man’s holdings may have, the way in which it may fit into an overall transaction with Woolworths or irrigation authorities or the regulatory requirement of planning requirements is neither here nor there. It might be relevant in the sense that they should not be looked at, but if they simply reveal that the interest is to secure and maintain a borrowing which is used to make an acquisition of something which itself produces income, then the answer ought to be straightforward.

FRENCH CJ: On account of the recurrence of the interest payment?

MR WALKER: Recurrence will be a badge. It is a frequent way in which interest payment is shown to be something which is necessary periodically to maintain a borrowing. We have, of course, recurrency in this case. We do not have to argue more than we are presented by the facts, but obviously interest payments can, in certain circumstances, without recurrency, also be deductible. Upfront interest payments are not unfamiliar.

We did not have any of the difficulties of Macquarie Finance, which has been deployed against us in writing, but, in our submission, in a way that does not pay sufficient regard to dispositive features of that case. There there was an option to switch from payment of interest on the notes in question to pay dividends in place on the staple securities.

FRENCH CJ: But was not an important feature of that case, Macquarie Finance, that the arrangements were part of an overall attempt to comply with, again, capital raising or prudential capital requirements?

MR WALKER: It cannot be gainsaid that that was part of the setting and not a merely incidental part of the setting of that case but, in our submission, it has never been adumbrated as a principle of law that if a capital asset, or in this case capital funds, are being acquired to meet regulatory purposes as opposed simply to produce commercially the capacity to derive income, that that turns the periodic payment of interest on a borrowing to constitute or acquire that capital asset a non-deductible or non-revenue expense. Macquarie Finance, of course, does not pronounce anything in so general or abstract terms, nor could it, in our submission.

FRENCH CJ: It is a matter of characterisation, having a look at the particular circumstances of the transaction. I suppose the problem here is, given the broad nature of the almost categories of indeterminate reference that one gets into, are we really dealing with anything more than a contested characterisation as distinct from a matter of principle?

MR WALKER: Your Honour, that is a hurdle I have got to jump for special leave. That is why I went to paragraph 105 because it is expressed in terms which are sufficiently general, in our submission, to show that the finding here, the decision here, is not rooted in anything special or particular about this case. Indeed, that is what makes germane a comparison of this case with Macquarie Finance, just to name one of the authorities the parties have gathered in their written submissions.

FRENCH CJ: Let us suppose there is an overbroad statement for a moment. Are you likely to be any better off on a narrower proposition?

MR WALKER: Yes, is the answer. If structural advantage, which appears to be - - -

FRENCH CJ: Justice Allsop founded his conclusion on that also, I think.

MR WALKER: Yes, I have said all four judges below. In paragraph 105, as a convenient culmination of reasoning and as the Chief Justice has pointed out at first instance as well, we have this notion of structural advantage. It seems to be inseparable also from regulatory requirement. That transcends the particular facts of this case. There are many borrowings which are made in order, directly or indirectly, to satisfy requirements of law, whether they be, as I say, the purchase of particular safety equipment or whether it be, in here, the acquisition of capital of a particular form in order to satisfy one’s ambitions either to keep trading or to trade at a higher scale as a financial institution.

It is for those reasons, as the terms of paragraph 105 themselves bespeak, that there is nothing special to the St George capital raising in this case which could be seen to determine the outcome. Justice Perram’s reasoning observes what might be regarded as unremarkable, namely, that there is a so-called structural advantage, a metaphorical expression that has found its way into this area of the law and economic thinking, a structural advantage flowing to the bank from the raising of the capital. That is why we seek to move to concrete examples or parallels.

There is a structural advantage accruing to a farmer who acquires 10,000 further acres as a capital asset. The fact that it is structural, that is, that it supplies the wherewithal, the framework by which one can go on to derive income or more income, is, as Steele’s Case says, of no moment whatever in determining the deductibility of interest payments, as it happens, made recurrently and periodically here and, as it happens, made on condition that if they are not made, you will cease to maintain that borrowing.

In our submission, this case therefore cannot be seen simply as an example of Professor Stone’s warning about certain forms of language in legal stipulations that simply will require case by case judicial supply of content. This is a holding which, of necessity from the Full Court of the Federal Court, will and must provide guidance that needs to be anxiously considered whenever there is something in the nature of structural advantage, perhaps with or without, certainly with regulatory requirement annexed to it and a borrowing where interest has been paid periodically in order to have secured that structural advantage. How could people advising or at first instance deciding overlook the authority of this decision particularly expressed in general terms, as it is in paragraph 105?

We do not criticise the fact that his Honour uses general terms or terms which lend themselves immediately to extrapolation to other transactions. That is in the nature of legal reasoning pointing to those matters which are relevant for the decision of a case in light of established principle. What we criticise, with respect, and seek the further opportunity

to establish as error in this Court is the way in which there is this equation expressed between the acquiring of structural advantage and the characterising as of on capital account of interest paid in order to secure and maintain the borrowing by which that structural advantage is obtained.

That, in our submission, presents a crux, a considerable difficulty, in reconciling what on an equally general basis can be gathered from the authorities in this Court, not only the Dixonian statements which are classically repeated over and over in this context, but also the more recent gathering of those concepts in Steele’s Case, a gathering in terms which, in our submission, sit most uneasily with paragraph 105.

One solution to that is to observe, as obviously one must observe, Steele’s Case, as it were, in stare decisis cannot be competed with or detracted from by anything in this decision. Well, of course not, but in a hierarchical system, in our submission, what the Full Court of the Federal Court says in purported application of the principles considered in Steele’s Case itself becomes of great importance for this Court from time to time to supervise. This, in our submission, is an ideal vehicle, a good opportunity, with relatively very circumscribed facts to attend to an important question, particularly as that important question has been expressed in the unfortunately metaphorical terms of structural advantage that one has here.

We have drawn to attention in the ancillary material in the folder at tab 10 an interesting indication that those administering this statute see that quasi equity will be a label attached in the case of thin capital to loans so as to use this notion of structural advantage being secured and rendering the interest therefore not deductible of a capital nature. That, in our submission, shows very broad and important ramifications which this case would provide an opportunity to consider and, in our submission, to render error free by overturning the decision before your Honours.

FRENCH CJ: What part of that material are you referring us to?

MR WALKER: In particular, your Honours, on page 11 in paragraph 44, which I do not need to read. There are obviously important ramifications which are seen, as I say, right at the heart of the administration of the Act, whether or not that of course lacks any legal authority, but it is a useful indication from an important source of the broader ramifications. For those reasons, in our submission, this is a case that warrants the grant of special leave.

FRENCH CJ: Thank you, Mr Walker. Mr Murphy.

MR MURPHY: Thank you, your Honour. The Commissioner’s submission in this case is that this case does not raise any issue of principle. At best, as your Honour put it a little while ago, it raises only the question of characterisation in accordance with established principles. Those principles, your Honour, are clearly set out in the reasoning of his Honour Justice Perram. He sets those principles out at paragraphs 77 and 78. He refers to the seminal decision in Sun Newspapers. He then subsequently examines all the circumstances of this particular case, all the unusual features of this particular case, and in paragraph 101 he then makes a point that:

The question then devolves to the ordinary kind of inquiry required by Sun Newspapers.

What he then does is to determine the nature of the advantage sought, the structural advantage. Structural advantage, your Honour, is not a metaphor. Structural advantage here was the overall advantage which was designed to be achieved by the interest payments as part of the integral arrangements resulting in giving rise to the particular borrowing. The structural advantages which were identified in paragraph 102 were structural advantages which evolved from the very unusual circumstances of this case.

This is not, as our learned friends would have it, a simple borrowing of the type which was maybe considered by this Court in Steele. A simple borrowing, your Honours, is essentially the obtaining of funds for a limited term and the interest paid is the cost of obtaining those funds for that limited term. This is not that case. As the court found, the reason why the applicant entered into this transaction was a need to comply with the Reserve Bank requirements, the tier 1 and tier 2 requirements. Those requirements required the obtaining of permanent funds.

The interest payment which was made in this particular case was the cost of obtaining those permanent funds. In this case, true it is that the debenture itself provided for the repayment of the loan made by Macquarie from the LLC which it had established for the purpose. But as the Court found - - -

FRENCH CJ: St George Bank.

MR MURPHY: Sorry, your Honour?

FRENCH CJ: St George Bank. You said Macquarie.

MR MURPHY: Sorry, your Honour, yes, St George Bank – which it had borrowed from the LLC for a specific purpose.

FRENCH CJ: The interest payments themselves were directed ultimately to the funding of dividends?

MR MURPHY: That is correct, your Honour. There was a direct link between the dividend paid and the interest payment. Those links are set out, your Honour, at about application book 104 in paragraphs 68 and 69. The interest payments were in that sense the cost of the funds obtained by LLC which were necessary for Macquarie to retain or to comply with its own banking licences. The interest payments, your Honour, were not conventional interest payments.

My learned friends have made much of the point that if the interest payments were not paid, then St George Bank could sue for them, but the real point, your Honour, is that, unlike most interest payments where there is an obligation to pay the interest payment come what may, the obligation to pay the interest payments under this particular structure, under this particular arrangement, was contingent upon St George Bank solvent. The obligation to pay the interest was also subordinated to the obligation to pay all other creditors and, as the court pointed out, it was subordinated to the payment of dividends. So the court has in paragraph 102 identified the structural advantage of the whole transaction and then in paragraph 104 sets out what St George’s argument essentially was:

St George objected that the payments of interest did not secure anything but the use for a limited term of the funds advanced under the debenture. The Commissioner, on the other hand, denied that the payments had that quality at all.

Your Honours, the reality was, and it was fundamental to the Reserve Bank requirements, that that money would never be paid outside the group. St George would have the use of that money for as long as it wanted to have the use of that money. It is in that context that his Honour then turned to the question of the interest payments, the characterisation of the interest payments themselves, and that is in, as my learned friend has taken you to, paragraph 105. They were an essential:

element in an overall transaction whose purpose was to achieve the structural advantage to which reference was made.

FRENCH CJ: But what does that term “structural advantage” mean which enables us to say, for example, borrowing for working capital purposes, this is not within it?

MR MURPHY: Your Honour, the structural advantage in this case was the - - -

FRENCH CJ: No, can you unpack the concept at all in a more general way?

MR MURPHY: Only by reference, your Honour, to what this Court said in Sun Newspapers. Your Honour, if I can take you back to the application book. There is a more extensive extract appearing at application book 31 of the decision in Sun Newspapers and the part is the bold part at the top where Justice Allsop extracts:

The distinction between expenditure and outgoings on revenue account and on capital account corresponds with the distinction between the business entity, structure, or organization set up or established for the earning of profit and the process by which such an organization operates to obtain regular returns by means of regular outlay –

That was developed by his Honour in the decision in Hallstroms to which reference is made at paragraph 56 of Justice Allsop’s decision and at page 33 where the extract is made:

As a prefatory remark it may be useful to recall the general consideration that the contrast between the two forms of expenditure corresponds to the distinction between the acquisition of the means of production and the use of them; between establishing or extending a business organization and carrying on the business; between the implements employed in work and the regular performance of the work in which they are employed; between an enterprise itself and the sustained effort of those engaged in it.

HEYDON J: Is borrowing to buy a farm acquisition of a means of production?

MR MURPHY: Borrowing to buy a farm would be the acquisition of the means of production, but the characterisation of the borrowing would not be solely dependent upon the fact that the moneys were in fact used for the purchase of a farm. This was the difference, your Honour, with respect, we submit, between the decision of the Full Court in Steele and that of the High Court. The characterisation of the borrowing does not depend upon the use to which the borrowed funds are put, that is, in the purchase of a capital or a revenue asset. The characterisation of the borrowing is determined by the nature of the payments made for that borrowing, that is, whether or not the payment interest is paid for the temporary use of funds. In Steele this Court held that even though the property in that case, Tibradden, was a capital asset, and that the borrowed moneys were used to apply that, the interest was nonetheless deductible because it was nonetheless paid for the use of funds.

FRENCH CJ: Suppose one wants to reverse the metaphor, you can think of capital to meet the capital requirements is a kind of building and the payment of interest is there to keep it up.

MR MURPHY: That is right, your Honour.

FRENCH CJ: .....metaphor in this area, of course.

MR MURPHY: We can get very much lost, your Honour, but at the end the question still comes down to, what was the advantage which was sought and was the advantage of a structural nature, that is, did it go to the organisation itself, the business itself, or did it go to the operation of the business? Moneys borrowed, your Honour, off the purpose of working capital go to the operation of the business. They are borrowed and they are lent out. Here in this case, as his Honour noted and Justice Allsop also found, there was no need to borrow for working capital. The whole genesis of this transaction was the capital structure of the bank, that is, the ability of the bank to carry on, particularly of the applicant, its business by complying with the tier 1 and tier 2 requirements.

Your Honour, we say that this is no more than a case of characterisation. There is no question as to the fact of what the relevant principles were. They are the principles which are have set out in cases such as Sun Newspapers, Hallstroms and also in Steele. There is no question that the court applied those concepts and if there is any error, and we say your Honour that there is no error, if there is any error, it is an error which is confined to these particular facts and that error is only, as we say your Honour, in relation to the question of characterisation. It is not in relation to the question of principle.

Your Honour, we have also pointed out in relation to the question of special leave that this case is different to many other cases in that there are now new provisions of the taxation legislation, namely, Division 974, an aspect of which was considered in this case and, more recently, Division 230, the so-called TOFA principles. The relevance of these provisions, your Honour, are that the ongoing applicability of anything this Court might hand down in this particular case is going to be limited. We say it would certainly not apply to the bank and we would say that it certainly would not apply to very large taxpayers. It may apply to some small taxpayers, but in that regard, your Honour, since 1 July 2004, the deductibility of interest has largely been regulated by the so-called debt/equity provisions in Division 974.

If you characterise or if a particular transaction is characterised as being in relation to an equity interest, and we would say that applying the principles in Division 974 that this would be the case here, then the

expenditure is simply not deductible. You just do not get to section 8. In more recent times we have the TOFA provisions which apply to larger taxpayers, that is conceded. The effect of the TOFA provisions of relevance or ongoing relevance to this case is that the income capital question which arises under section 8 just simply does not arise, section 230-15(4). Unless your Honours have any further questions, those are our submissions.

FRENCH CJ: Thank you, Mr Murphy. Yes, Mr Walker.

MR WALKER: Just to the last point, your Honours. Of course section 8 itself will continue to be of great importance, one would have thought, in the sense that anything may be forever. The matters that we have drawn to attention arising from the culminating expression of reasoning in paragraph 105 certainly transcends the classes which are now dealt with by new and different forms of statutory stipulation.

Your Honours, in our submission, on those transcendent and continuing matters of importance, my learned friend’s address, in fact, continues what we would identify as an important kind of error useful for this Court to examine and if we be correct, to correct it, and that is the repeated conflation of matters of principle and matters of interest. Of course the price paid to obtain the extra 10,000 acres of farming land or the price paid to obtain something which constitutes tier 1 capital is itself a matter of capital and because of the character of what is being obtained thereby.

But the borrowing to pay that price in whole or in part is a matter which raises the question whether the price of that borrowing – usually called interest and in this case both explicitly and inherently interest – that has always prima facie and for obvious reasons been by a combination of its usually recurrent nature and by the fact that it secures and maintains that borrowing necessary to pay for the capital asset, itself being used to derive income, as being on revenue account. That conflation, in our submission, informs the entirety of the reliance that was placed and addressed today on the classic statements that are, for example, excerpted on pages 31 through 33 in the application book to which our learned friends drew attention.

We would say as well in relation to the argument our learned friends have presented in address that the question of subordination or, for that matter, a condition following solvency in order to trigger an obligation to pay, plainly does not play a dispositive role in the way in which this case was decided. The notion that subordination will remove the deductible nature of interest paid on a borrowing simply because it has a quality of subordination in relation to other borrowings, would be, in our submission, startlingly novel and so startlingly novel as not to find any basis or

foundation as being a dispositive or even informative factor in any of the reasoning by all four judges below.

Another matter referred to by my learned friend, referring to the special factors apart from subordination, was what I will call the intra-group nature of some of the linked transactions in the overall exercise of obtaining these capital funds by the periodic payment of interest to maintain the borrowing in question. The fact that a payment is intra-group has never hitherto been seen at the level of generality that I have just made, has never hitherto been seen as a reason, in the absence of something which is contrary to a market or shows a non-arms-length aspect, to be in itself a badge of rendering what would otherwise be a deductible payment, one on capital nature.

If I borrow from my parent or a parent borrows from a subsidiary, it has hitherto never been doubted that the interest as a matter of contract between two separate entities required to be paid subject to there being no exceptional case of non-arms-length above market, for example, will be, for all the reasons that Professor Parsons has pointed out in the passages to which we have drawn attention, expected to be deductible, so long, of course, as the borrowing is in order to acquire or to enable something to be done itself to derive income.

It is for those reasons, in our submission, that one finally comes to the last of the three special factors and sees that it too has nothing to say about vindicating paragraph 105 as either so special of this case or as containing no error so as to resist special leave. The fact that this capital was to be permanent – and the word “permanent” of course is just a matter of human hubris, it really means indefinitely – does not distinguish it one whit from the acquisition of the extra 10,000 acres by a farmer. That has all the same qualities of permanence. For those reasons, in our submission, none of those factors render this an unsuitable vehicle.

FRENCH CJ: Thank you.

The applicant in this matter seeks special leave to appeal against the decision of the Full Court of the Federal Court holding that interest payments under a debenture were outgoings of capital or of a capital nature. The outgoings were connected with the raising of additional capital by the applicant to meet the capital requirements of the Reserve Bank of Australia following the applicant’s merger with Advance Bank Australia Ltd.

The debate in the end is one of characterisation in the application of longstanding principle. In our opinion, it does not warrant the grant of special leave. Special leave will be refused.

Does anyone seek costs?

MR MURPHY: Yes, your Honour. The Commissioner does.

FRENCH CJ: All right. Special leave is refused with costs.

We will adjourn briefly to reconstitute for the next matter.

AT 11.19 AM THE MATTER WAS CONCLUDED